Oil markets are supplied for now, but there is not much wiggle room
It was that time of the month last week. Both the International Energy Agency (IEA) and OPEC published their monthly reports. Markets are tight, yet the oil price was in for the largest intra-day fall of Brent in two years ($5.46 per barrel on July 11). It traded slightly lower again well into this week.
The IEA warned of capacity constraints and revised its non-OPEC supply forecast slightly downward while OPEC maintained that the organization was ready to ensure that markets were adequately supplied.
Last week’s bullish indicators did at first sight not justify a drop in the price of oil.
During the week ending July 6, US stocks drew at a staggering 12.6 million barrels, which was 4.5 million barrels above consensus. This was mainly due to lower crude imports. However, the week after stocks drew by an unsuspected 620,000 barrels according to the American Petroleum Institute.
Canadian outages persisted, yet mid-continent crude US imports increased slightly. The macro picture has not changed drastically and is not going to in the near future. Venezuela is not producing anymore and Libyan production is down 500,000 bpd compared to a year ago, mainly due to internal security issues.
Why then did the oil price have a downward trajectory last week? There are probably two main reasons:
First, markets started to factor in what monetary tightening and the possibility of trade wars mean for the global economy, international trade and supply chains. If tensions escalate further, global growth forecasts will have to be downgraded, supply chains will start to become partially localized and countries will export and import fewer goods. If these scenarios play out, which they might, they have the potential to impact global crude demand down the line.
Second, it became clear that OPEC+ made good on the promise to put more barrels on the market. They had agreed at their Vienna meeting on June 22/23 to put an extra million bpd on the market starting July. That will neutralize the over-compliance of a December 2016 agreement where OPEC and 10 non-OPEC countries had agreed to take out 1.8 million barrels, to jointly address the huge inventories overhang at that time. The GCC countries and Russia have already increased production by 550,000 bpd — and this before the month is out.
There were other factors as well: KSA is in talks with clients to release more crude and the US is debating over whether to release some of its strategic reserve. Lastly, Russia also has considerably more headroom and may choose to use it to please the US president.
The big unknown is what will happen to Iranian exports when the sanctions are set to start in November. The Trump administration has drafted biting regulations aiming to take out 100 percent of Iranian exports. This means that Iran would be hit harder this time than during the last sanctions. We can already see fewer tankers leaving Iranian ports. It will become increasingly difficult to insure ships and cargo from Iran, because no global insurer can afford to forego access to the juicy US market.
We can see long-term supply constraints, which are Venezuela and Iran once the sanctions hit.
Exports to Europe fell by nearly 50 percent — about 290,000 bpd. That said, most Iranian crude is exported to Asia — China taking 600,000 bpd and India 500,000. While both may want to accommodate the US position, they are also battling supply shortages from falling Venezuelan production (China receives 250,000 bpd from Venezuela and India 350 bpd). We will have to wait until December to see how that particular situation unfolds.
All in all, we can see long-term supply constraints, which are Venezuela and Iran once the sanctions hit. In the medium term, infrastructure constraints in the lower 48 will get resolved. In the short term, we can expect Canadian exports to resume.
The real question will be what effect monetary tightening in OECD countries will have on global growth, as well as how trade wars unfold and what that means for global oil demand.
On the supply side, the IEA still foresees non-OPEC supply to grow by nearly 2 million bpd in 2018 and 1.8 million bpd in 2019. That may all be good.
The main concern of the IEA was spare capacity. In the short term there should be just about sufficient headroom. Saudi Arabia is estimated to have about two million bpd, of which one million is accessible quickly and without major investment. KSA is 540,000 barrels shy of reaching that 11 million bpd mark. This is sufficient for now and there is also that second million bpd in the longer term. This is why OPEC says that the organization will be able to keep markets supplied adequately.
The reason spare capacity has become so central is that the sector as a whole is hopelessly under-invested. During the lean years of 2015/2016, international oil companies scrapped as much as 40 percent of their scheduled investment. They have not really resumed their investment programs to the degree required. To say the least, this is sub-optimal in an ultra-long cycle business, which the oil sector is. It means that the world will be adequately supplied with oil in the short term, but that there may be concerns about the long term if the forecasted robust demand growth persists and capacity is not added. In the meantime, the commodity seems to have established a trading range of between $70 to $80.
- Cornelia Meyer is a business consultant, macro-economist and energy expert. Twitter: @MeyerResources