Geopolitics sends oil prices to new highs
Oil’s runaway streak shows no signs of slowing, on the back of renewed US sanctions on Iran, and the impact of lower oil inventories. Brent crude futures continued climbing on Monday, rising as high as $78.20, with WTI passing the $71 a barrel mark for the first time since November 2014.
Monday’s monthly oil market report from OPEC suggests that the global supply glut has all but disappeared thanks to widespread compliance with the deal among OPEC and non-OPEC producers to trim production. OECD commercial oil stocks were just 9 million barrels above the five-year average for the month of April, according to the group’s figures. Some analysts go further and place them 25 to 30 million barrels below the five year average.
Whatever the true figure is, markets are pretty much in balance, and getting tighter, as reflected in recent price movements. The steady price gains brought about by the output-cut deal of course received a boost when President Trump withdrew from the Iran nuclear deal and reinstated sanctions. Trump’s announcement also came against the backdrop of the dramatic decline of Venezuela’s production. OPEC yesterday estimated the country produced just 1.5 million bpd last month, compared with 2.4 million bpd 2016. There is also a question mark over the reliability of production in Nigeria, Libya and Northern Iraq due to their particular set of geopolitical circumstances. US crude inventories have also edged lower in recent weeks, falling 2.2 million barrels for the week ending May 4, an uncharacteristic drop for the second quarter.
US sanctions on Iran — due to come into effect after 90- and 180-day wind-down periods — will undoubtedly impact the roughly 2.6 million bpd in Iranian exports of crude and products. While European leaders have said they will continue to work to save Iran’s nuclear deal, such efforts will not affect the impact of sanctions on the country.
While the overhang in inventories has been eliminated, the question now is how stretched markets will be.
The biggest importers of Iranian crude are China India and Turkey, and much will depend on their response to the US’s new sanctions. Perhaps more important than the trading and importing of crude is how such transactions are financed. The extraterritorial nature of US sanctions would render it impossible for international banks to retain access to the juicy US market if they are in violation of sanctions.
The uncertainty of how China, India and Turkey will react accounts for the very varied assessments by analysts of the impact on Iranian exports, with forecasts varying between 200,000 to 1 million bpd taken out of the market once sanctions set in.
Given that markets are so tight, every barrel matters as far as the price is concerned. The demand picture looks rosy as long as the global economy is humming. The International Energy Agency (IEA) foresees a demand growth of 1.5 million bpd for 2018. As we set into the driving season of the US we can expect demand to peak for the months of July, August and September. There is, however, an incremental 800,000 bpd of new non OPEC production hitting the international oil markets this year, according the IEA. There is also spare capacity, especially in Saudi Arabia. The Kingdom has a capacity of around 11.5 million bpd, but only produced 9.9 million barrels in March. Saudi Arabia’s Ministry of Energy last week said it would be happy to ramp up exports to compensate for potential shortfalls of Iranian supply, but insisted that it would only act in coordination with other producers.
In the end the demand supply balance as well as the price will depend on how much Iranian crude gets taken out of the market. And while the grand pact to reduce oil output has eliminated the overhang in inventories, the question now is how stretched markets will be. Saudi Energy Minister Khalid Al-Faleh said that he prefers markets tight. It’s easy to see his point, as only higher prices will convince international oil companies to ramp up investment programs, following the widespread cancelation of projects when prices hit their lows in 2015-16. The privatization of Saudi Aramco would also benefit from higher prices. One thing to consider as the oil price rises, is when demand destruction will set in. The higher the price, the bigger the incentive to consume less oil; or switch to and research other energy sources.
- Cornelia Meyer is a business consultant, macroeconomist and energy expert. Twitter: @MeyerResources