Today’s oil markets look a lot like New England weather—poised to change in the blink of an eye, or maybe more aptly, on the next set of released data. Earlier this year, the International Energy Agency (IEA) first predicted that U.S. production growth (which continues an impressive expansion despite a recent slowdown) could single-handedly cover increases in global demand. More recently, reacting to a spate of (planned and unplanned) supply curtailments, including impending sanctions and robust economic growth, the storyline changed to one of needing more prompt barrels to avoid a future price spike. The Organization for Petroleum Exporting Countries’ (OPEC) summer meetingproduced an agreement to keep oil markets adequately supplied even as Venezuelan, Nigerian, and Libyan output seemed in peril. Canadian and U.S. supplies were impacted by logistics and infrastructure constraints, and the North Sea dealt with union contract disputes.
In the past few weeks alone, sentiment and market signals have reacted to the supply side “news” of Saudi shipments being briefly disrupted transiting the Bab el-Mandeb strait; Iranian military exercises in the Strait of Hormuz; stepped up efforts by the Trump administration to double down on Iran sanctions with the formation of the Iran Action Group (intended to put maximum pressure on importers of Iranian oil to comply with impending U.S. oil sanctions) and the attendant indication of lower liftings from some quarters; the announcement of crude sales from the Strategic Petroleum Reserve (SPR); and continued volatility in Libya and Venezuela. And that’s without any disruptions from hurricanes in the Gulf of Mexico!
Not to be outdone, alternating demand side projections tied both to strong and weakening global economic projections, dollar strength and renewed prospects of impending trade wars moved Brent prices (to four-month lows at $70/barrel) back into contango, dragged speculative longs to eleven-month lows and caused OPEC stalwarts to rethink the timing and magnitude of delivering excess barrels. Seasonal refinery turnarounds, when demand for crude will be weakened, are only weeks away. Both the August IEA and OPEC monthly reports suggest that continued OPEC production at current levels imply recreating a global surplus in 2019.
Over the past several days, however, oil prices have once again gained renewed strength with front month Brent exceeding $76/barrel, still “range-bound,” but now at higher levels as the threatened Iranian losses may be raising the price floor.
This week’s announcement of a preliminary deal on a revamped U.S.-Mexico trade pact only slightly moved the needle, and heightened near-term considerations on both sides of the supply/demand equation continued to hold sway with the primary focus aimed at calibrating the “success” of Iran sanctions. On Monday, August 27, the six-country Joint Ministerial Monitoring Committee (JMMC)—the group assigned responsibility for overseeing the OPEC/non-OPEC compliance—convened by telephone to discuss oil market conditions and to plot a course of action over the next several months. Saudi Arabia, which co-chairs the group, has steadfastly maintained that the alliance’s decision to increase production this summer contains no individual country caps, while Iran has protested that other OPEC colleagues should not benefit from the imposition of “illegal” sanctions by increasing output to absorb what had been Iran’s market share. The group, which includes the ministers from Russia, Saudi Arabia, Kuwait, Venezuela, Algeria, and Oman, next meets in September in Algiers, at which time Iranian Minister Zanganeh intends to press his case in person.
And while the U.S government has been adamant in its insistence that maximum pressure needs to be exerted with respect to reducing Iranian oil exports to zero, realistically, there is simply not enough readily available spare oil production capacity in the world to replace the loss of all Iranian barrels (some 2.4 mmb/d), coupled with the potential for further reductions in Venezuela, Libya, Nigeria, and elsewhere. The Trump administration’s announcement to sell SPR oil (mandated by the budget agreement), while designed to calm markets, is inadequate in volume, duration, and quality/characteristics to offset such a loss without significant price pain. And commitments and offers by other producers to offset any losses are likely to be tempered by logistical constraints as well as questionable demand outlooks, including those attributable to the impacts of ratcheting up tariffs and trade wars.
To date, the Trump administration appears to be making significant headway in persuading purchasers of Iranian oil to significantly reduce their imports well in advance of the November 4 deadline. Purchasers in Europe as well as parts of Asia, most notably South Korea, have put the effort on track to cut Iranian export flows by 700,000 to 1 million barrels per day—but still less than half the targeted level. Shipping has become a significant obstacle, although global analysts anxiously await upcoming loadings data. China, for its part and despite imposing tariffs on other energy-related goods, continues to import U.S. crude oil, even as it argues for sustaining Iranian volumes as well. And the lure of acquiring deeply discounted Iranian barrels suggests such purchases will continue.
Over the past several years, our previous commentaries have argued that oil prices reflect a combination of fundamentals and sentiment, including news events (headlines), perceptions of near and longer-term policy pronouncements (timelines), and emerging issues that encompass things like sanctions, tariffs, trade wars, and geopolitical events that impact both supply and demand. Price activity over the past several weeks persuasively demonstrates that point and suggests an outlook of more of the same as the final quarters of 2018 play out. Price movements in prompt barrels continue to display day-to-day volatility and in themselves are headline sensitive—both on the upside and downside.
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