Crude oil supply glut or not?

Ivanova, portfolio manager at Expat Capital, writes on the recent volatility in the oil price…

WTI futures increased 17.5 per cent from August to October on expectations for Iran sanctions. However, the price then dropped 34.4 per cent from this year peak in October on concerns about global demand and waivers of the Iran oil sanctions.

Demand concerns are actually based on OPEC demand estimates for 2019 in November that plunged by about 0.07 mb/d. On the other hand, US Iran oil sanction waivers to countries, comprising 75 per cent of the third biggest OPEC exporter volume, seem to mismatch their imports before sanctions with roughly about 0.8 mb/d. Additionally, the other 25 per cent of 3.3 mb/d of Iran’s oil exports (European countries included in that number), also need to be compensated with increased production from other sources. Those waivers are also only temporary, announced to last for 180 days. Some ‘US allies’ may consider choosing alternatives. In the meantime, Japanese refineries started seeking extension of the waivers.

Although shale production is growing, some constraints persist. The pipeline capacity of the Permian basin is about 2.8 mb/d whereas the oil production much exceeds that capacity and grows. The pipeline capacity is expected to increase by about 2 mb/d in late 2019 and double by 2020. Costs of shale producers are believed to be between 50 and 55 US dollars per barrel. Low crude oil prices will delay or even cancel those projects and create credit default concerns, as most high-yield bonds in the US originate from the energy sector. In this sense, OPEC might not be eager to make a quick decision on cuts and thus stabilise the price.

Recent increase in US inventories might be explained by seasonality and higher petrol needs in the coming winter season. That could be due to the anticipated introduction of sanctions on Iran with US producers positioning themselves to replace Iranian volumes, as South Korea and Japan suspended Iran oil imports in advance and Japan started importing only after waivers were granted. That surge in inventories comes after a period of refinery maintenance and a hurricane season as well. 

The oil market seems rather balanced, especially bearing in mind that Libya is increasing production after a long period of disruption, although it is not currently among the top five OPEC producers and there are no disruptions in other producer countries. Prices tend to move with a lag amid quite patchy data. In case of extremely cold weather, disruptions, improvement in demand expectations or global growth, the current price will turn out to be too low. It is rather a matter of time any of the before-mentioned events to occur. Moreover, if China-U.S. trade dispute gets permanently resolved, global growth prospects will look much better. If this dispute results in low tariffs globally, trade will be stimulated and demand boosted. Eventual OPEC plus Russian production cuts will move the price up slightly, but with increasing restrictions on supply these will probably lead to a shortage and thus more substantial price increase in the mid-term since supply is relatively inelastic as compared to demand, and production increase with existing bottlenecks needs time.

 
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