Crude oil is turning into a hot commodity as prices are soaring on falling inventories and the Trump administration’s warning to companies to cease buying Iranian oil.
Oil prices traded lower in the first half of June, which was followed by huge gains in the second half. This month was a period of erratic global politics that injected a considerable amount of volatility and the stage is set for further geopolitical confrontation.
That decrease eliminated inventories in developed countries by about 340 million barrels and returned total inventories to around their five-year average.
The Saudis appear to have emerged as the winners from last week’s meeting of OPEC, and the subsequent talks between OPEC and its allies in the deal to restrict output. The outcome of meetings seems to indicate that crude oil supply should rise by as much as 1 million bpd.
Last month, OPEC oil ministers reached a deal to raise production quotas to add 600,000–800,000 barrels a day, effectively returning a third of the barrels that have been withheld since January 2017. OPEC ministers have agreed to a nominal production increase of a million barrels a day to be divided between cartel members and non-OPEC partners, including Russia, which together cut production last year by about That’s based on the assumption that OPEC and allies will return to 100 per cent compliance with the November 2016 cut of 1.8 million bpd from a current situation of over-compliance. However, the reality on the ground is that many OPEC countries lack the ability to pump their full quotas.
Saudi Arabia is the only producer that can ramp up output significantly within a short period of time. The market consensus after the OPEC meeting in Vienna on June 22 and the talks with non-OPEC allies the following day was that the agreements reached wouldn’t actually result in an extra 1 million bpd reaching global markets.
While there is some debate on the likely increase in supply, the upper end of the range is around 600,000-800,000 bpd. The markets were also dealing with the outage at Syncrude Canada’s 360,000 bpd oil sands facility near Fort McMurray, Alberta, which a spokeswoman confirmed will remain offline through July. Traders expect this to reduce crude flows to Cushing, Oklahoma, the delivery point of the US crude futures contract.
In addition, a power struggle among the two parallel Libyan national oil companies created uncertainty on the country’s export ability. Meanwhile, Venezuela is mostly enduring supply risk. Its production has already plunged by about 40 per cent since 2015 due to a gruelling recession, civil unrest and an exodus of workers from the country’s state-owned oil firm, Petroleos de Venezuela. The supply increase agreed by OPEC and its allies last week was primarily intended to offset these losses.
The decision by US State Department to encourage all countries to shun energy imports from Iran supported crude prices. The Trump administration has no compunction about making harsh demands to various countries, including US allies, to cut off Iranian oil. The US government is calling on its allies to zero out imports of oil from Iran by November 4, or else face sanctions, and Washington is leaning towards granting no waivers at all.
Some top oil buyers of Iranian crude are already thinking about shunning Iran oil. It is yet to see what will China and India, Iran’s two biggest oil customers, will do. It’s unclear if either has made a decision yet. While Beijing has held strategic talks with the Middle East nation, it hasn’t disclosed whether it might scale back imports in light of renewed US sanctions.
When the restrictions were in place earlier this decade, the Asian nations had persisted with purchases from the Islamic Republic in spite of American criticism. Meanwhile, India plans to seek some exemptions to continue Iranian oil imports, and is looking at alternate payment mechanisms.
Given that the Saudi Arabia looks to provide lion’s share of any increase in output, watching its export numbers and price signals in coming months will be the key. In fact, Saudis are already supplying more crude. Saudi seaborne crude exports were 7.06 million bpd in May, the most in a year, the data showed.
Prior to the November 2016 agreement, Saudi Arabia was regularly exporting more than 7 million bpd. But it’s also worth noting that only in two months, January and February in 2016, did the kingdom ship more than 7.6 million bpd.
What this shows is that the Saudis definitely have the scope to export more crude, but boosting output above 7.6 million bpd on a sustained basis isn’t something they have done in recent years.
The developments mean there are curbs on the outlook for global supply, and it seems as though OPEC and its allies will take a gradual approach in restoring production as the group combats the ongoing rise in US outputs.
Meanwhile, US exports are increasing continuously as rising domestic production of light oil, rising global demand, and the wide discount between the price of US crude and the global Brent benchmark in recent weeks are all helping more US crude find its way offshore.
Elsewhere, the escalating trade war between China and the United States threatens to halt surging US crude oil exports to China, which could destroy a huge source of future demand growth, drive down the cost of US crude and weigh on the balance sheets of America’s shale drillers.
US production is getting vital importance as its US oil rigs were decreasing through month after having touched their highest level since March 2015. US crude oil stocks have come down consistently since the top in March of last year, indicating a continued rise in demand.
Currently, crude stocks are in the middle of the 5-year range and indicate that they may have more room to fall, particularly if the economic growth for Q2 and later quarters touches 4 per cent. The Permian Basin in West Texas is on track to produce more oil within five years than any OPEC nation except Saudi Arabia, positioning the Texas Gulf Coast to rival the Persian Gulf when it comes to oil and gas activity.
By 2023, the shortage of pipelines to move oil, gas and natural gas liquids to Gulf Coast markets and beyond is expected to be alleviated by multibillion-dollar projects now under way or planned. A market structure known as backwardation persisted as WTI for August settlement was about $1.40 higher than the September contract, signalling a shortage after a Syncrude Canada oil-sands outage.
With the recent price moves being news-driven, we’re likely to see volatility and also price pullbacks. However, the medium to long term prospects for oil are very attractive and should be strong. Prices should push higher to at least $75-78 in the short term.