Oil Prices Plunge on Flood in Oil Market Ahead Of Midterms
OPEC and the U.S. are together adding enormous volumes of new supply, which together have softened the oil market.
In October, OPEC hiked oil production to the highest level since 2016, back before the oil production cuts went into effect, according to a recent Reuters survey. The higher output, led by Saudi Arabia and the UAE, come just as Iranian oil is going offline. Also, Libya saw a sharp rebound in production, although the country is not part of the OPEC+ production cuts.
The 15 countries in OPEC produced an average 33.31 million barrels per day in October, the highest since December 2016. That was also up 390,000 bpd from September. “Oil producers appear to be successfully offsetting the supply outages from Iran and Venezuela,” said Carsten Fritsch of Commerzbank (DE:CBKG).
Russia, which is not part of OPEC but part of the OPEC+ coalition, continues to produce at post-Soviet record highs.
Iran lost 100,000 bpd in October, due to buyers cutting back as U.S. sanctions near, but the losses were more modest than many analysts had expected. In fact, despite the hardline rhetoric from Washington, the U.S. is poised to grant waivers to several countries that are unable to cut their imports of Iranian oil to zero.
That was largely predictable. Top importers of Iranian oil, including India, China and Turkey, could not slash their purchases to zero without incurring a significant economic cost. The U.S. pressed these countries, but ultimately had to back down. “We want to achieve maximum pressure but we don’t want to harm friends and allies either,” U.S. national security adviser John Bolton said on Wednesday. He recognized that some “may not be able to go all the way, all the way to zero immediately.” The admission is notable since Bolton is widely known as one of the most extreme hardliners when it comes to Iran.
The waivers, along with efforts by Iran to work around the U.S. sanctions regime, means that the export losses could plateau. “It is doubtful whether Iranian oil exports will fall much further from their current level, however. After all, there are reports that India is to be granted an exemption by the US to buy Iranian oil. Without such exemptions, buyers of Iranian oil will risk US sanctions from next Monday,” Commerzbank said in a note.
Meanwhile, even as OPEC is boosting production, the U.S. is also adding supply at an impressive rate. The EIA just released U.S. production levels for August, revealing a massive month-on-month increase. The agency estimates that the U.S. produced a whopping 11.346 mb/d in August, an increase of 416,000 bpd from a month earlier. That level makes the U.S. the largest oil producer in the world, just a hair above Russia.
At 11.346 mb/d, the U.S. added 2.1 mb/d compared to August 2017, the largest increase over a 12-month period on record.
But even with OPEC production at a two-year high, and U.S. production surging at a torrid pace, the oil market is not necessarily on the verge of plunging into a new downturn. Despite the flood of new supply, the “surge does not seem to have overloaded the market,” according to Standard Chartered (LON:STAN). Crude oil inventories have climbed significantly, but part of the reason for the increase is that refinery utilization is way down. Refineries tend to go into maintenance after the summer, but Standard Chartered said this has been a “longer-than-usual maintenance season.” That has led to inventory increases, but still, inventories are right in the middle of the five-year average. That also included a scheduled release of oil from the strategic petroleum reserve, a volume that was previously legislated by Congress.
Nevertheless, market sentiment has soured, at least compared to before. Investors have sold off bullish bets on oil futures and the futures curve has flipped from backwardation into contango, a sign of increased bearishness.
“Given these (output) numbers, with Russia pumping hard and the United States and OPEC as well, and we are not really seeing a pickup in demand for another month … it could indicate we’re back to the good old $70-80 range that persisted through April and August,” Saxo Bank senior manager Ole Hansen said, according to Reuters.
John Kemp of Reuters argues that the surge in production this year is the result of the increase in prices in 2017 and the early part of this year. Enormous production increases tend to come 9 to 12 months after a shift in oil prices. And because oil prices have moderated since April, the production increases could also level off next year, suggesting that the blistering rate of growth seen in 2018 probably won’t last.
But for now, the flood of new supply may have put a cap on oil prices in the near-term, barring any unforeseen outages. – Nick Cunningham
Brent Oil Prices To Hit $80 Before Year-End
Oil prices have fallen around 15 percent over the past month, and concerns about oversupply have rushed back. OPEC and the U.S. are both adding enormous volumes of fresh supply, threatening to create a bear market for crude oil.
However, the souring market sentiment could perhaps outstrip what is justified. Goldman Sachs (NYSE:GS) argues in a report that the loss of supply from Iran, combined with thin spare capacity and resilient oil demand will push prices back up. The investment bank reiterated its forecast for Brent oil prices to hit $80 per barrel by the end of the year.
Part of the reason that oil traders have grown pessimistic on oil is that demand suddenly looks shaky. Specifically, demand in emerging markets appears weak, particularly as currencies have weakened against the dollar, which has magnified the price shock for consumers. However, Goldman Sachs says that when digging into the data, demand doesn’t seem to have changed all that much. “Our modeling and tracking suggest however that these concerns are likely excessive,” Goldman analysts wrote.
There are a few reasons for this, the bank argues. Oil demand is still growing at a brisk rate globally. More specifically, Chinese oil demand “continues to surprise to the upside despite the ongoing activity slowdown,” the bank said. Also, the impact of higher fuel prices in local currencies in emerging markets “will remain moderate in 2018 and have dissipated by mid-2019 at current oil and USD levels, which are our base case forecasts.”
Moreover, Goldman Sachs is not buying into the notion of a global economic slowdown, although it admits that this area is a little bit difficult to predict.
The recent narrative in the oil market has focused on the tension between the loss of supply from Iran versus higher OPEC production and weaker demand. The resilience of Iranian oil exports, combined with higher OPEC and U.S. oil production, has led to more pessimism regarding prices. Brent has crashed from around $86 per barrel in early October to the mid-$70s a month later.
However, this price correction might only have let some steam out of the market, recalibrating expectations lower, which could create more room to the upside. Goldman Sachs argues that Iranian oil exports will still decline from here, despite the likely issuance of waivers by the United States to some importers. That means that oil prices might be hitting a temporary low just ahead of implementation of U.S. sanctions on November 5, opening up upside potential thereafter.
“With October high-frequency oil inventory data pointing to a slowdown in stockbuilds globally and Iran production still set to fall, we believe that the market will end up in a deficit in November, setting the stage for a recovery in both Brent flat prices and timespreads,” Goldman analysts wrote.
The most crucial difference between Goldman and some other forecasters is the confidence in emerging market demand. The bank has emerging market oil demand growing by 1.55 million barrels per day (mb/d) in 2018 and 1.45 mb/d in 2019, which is above consensus forecasts. Goldman argues that data in emerging markets is lacking, and demand figures tend to be retroactively revised higher later on. If his is correct, the oil market might be tighter than most people think.
For instance, inventory data in many countries is often missing, so any slowdown in imports is often interpreted as weak demand, when in fact, an individual country might be simply drawing on inventories. This “destocking” doesn’t show up in the data, and market analysts wrongly think that such a country is trimming imports because demand is slowing. Goldman believes that this is occurring in China, where it thinks demand is much higher than the market believes.
Moreover, emerging markets might even recover in 2019, which could result in only a modest slowdown in the global economy, rather than a deeper downturn that some forecasters are eyeing.
Finally, any downturn in oil prices would likely be met by a cut in production from OPEC. The group seems to have grown more accustomed to higher oil prices, and now appears eager to put in place a price floor that is much higher than it was a year or two ago. Rather than the $50 or $60 that OPEC was comfortable with in 2017, the new floor might be somewhere around $70.
Going forward, OPEC will likely calibrate production levels to avoid a sharp decline in prices. “Only a large demand shock would push inventories sharply higher and prices sharply lower as the production cuts could not match the velocity of the demand decline,” Goldman argues.
Add it all up, and rather than the beginning of a deeper downturn, oil prices might be hitting a near-term bottom.