Analys
Brent crude in non-USD as expensive as in 2011 to 2014
In order to reach a consensus and keep the OPEC+ group united the latest proposal on the table for the upcoming meeting of OPEC+ on Friday and Saturday in Vienna is a modest increase of 300 to 600 k bl/d in 2H1. The proposal before the weekend by Saudi Arabia and Russia was an increase of 1.5 m bl/d. What is most imperative in our view is that the group is adaptive to market conditions going forward. Uncertainties on both the supply side and the demand side are significant. In the eyes of emerging markets (but also Norway) the oil price in local currency is today as high as it was when Brent traded at $110/bl from 2011 to 2014 with demand destruction naturally setting in at such a cost level. Rapidly escalating US – China trade tension is adding to global growth headwinds. With large uncertainties on the supply side the group should stay ready to increase production in order to avoid escalating pain for the consumers.
Bjarne Schieldrop, Chief analyst commodities
It turns out that Donald Trump’s tweets over the past months that “OPEC is at it again creating artificially high prices” are not just a whim. It is actually one of his core views going back more than 30 years. US lawmakers have tried to pass the NOPEC bill (“Non Oil Producing and Exporting Cartels Act”) for years. It will allow the US Government to sue OPEC for oil market manipulation. Earlier attempts to pass the bill have been blocked by President vetoes. Donald is however one of the big supporters of the bill. This bill is now rolling towards OPEC+ and the group certainly do not want to stir the pot by holding back to much oil creating too high prices.
Price action – Rebounding 2.6% ydy as OPEC+ seen to aim for modest compromise. Sinking back on trade war today
Following Friday’s 3.3% sharp sell-off on the back of Saudi Arabia’s comment that an increase in production is “inevitable” the Brent price yesterday rebounded 2.6% to $75.34/bl as the group was seen to aim for a modest compromise. An increase of 1.5 m bl/d has earlier been seen as the proposal by Russia and Saudi Arabia while the latest proposal said to be discussed is an output hike of 300 to 600 k bl/d. This helped the Brent price to rebound yesterday. This morning Brent is pulling back 0.6% to $74.9/bl following the queue of the sharp sell-off in Asian equities on fear that Donald Trump will add tariffs on an additional $200 billion worth of Chinese goods exported to the US.
Aiming for a compromise but adaption to market conditions will be key
In order to hold the OPEC+ group together and appease Iran, Iraq and Venezuela who have strongly opposed any increase in production the group now seems to aim for a compromise of a modest increase of 300 to 600 k bl/d at the upcoming meeting on Friday and Saturday this week. It has all the time been argued that any revival in production will be gradual and adapted to market conditions. To be reactive and adaptive to market conditions seems to be even more important now due to significant uncertainties for both supply and demand.
The global economy ex the US has been cooling since the start of the year and the US – China trade tension is escalating rapidly with an additional $200 billion worth of exports to the US at risk of getting tariffs. This is not good for global growth and for oil demand growth. The strengthening of the USD, especially versus emerging markets is bad both for global growth and for oil demand growth. An oil price of $75/bl seems fairly modest, neither too hot nor too cold. However, if we measure it in local currencies like the Norwegian krone the oil price now is just as high as it was during the period 2011 to 2014 when Brent crude was trading at around $110/bl. The same goes if we take JPM’s EM currency index and adjust Brent crude prices from July 2010. So in the eyes of the emerging market consumers the oil price today is just as expensive as it was during the 2011 to 2014 period. That means that demand destruction is naturally setting in at these prices for the EM’s. And, since EM’s holds the lion’s share of the world’s oil demand growth this is probably not insignificant. It is thus highly important that OPEC+ is sensitive, adaptive and reactive to oil demand conditions going forward.
The supply side is of course just as challenging to gauge as production in Venezuela is declining rapidly but could as well disrupt entirely and unpredictably. US sanctions towards Iran, a sharp decline in Nigeria’s production in June and increasing violence in Libya where the destruction of two of five crude storage tanks at Ras Lanuf“ may take years” to rebuild are all contributing to a highly unpredictable supply.
For a large share of the world’s consumers the oil price is already as high as it was during 2011 to 2014 and OPEC+ does definitely not want to risk that the oil price moves yet higher as the world economy is already facing challenges. Thus adaptivity to market conditions must be the most imperative goal of OPEC+ at the upcoming meeting this week as the goal of getting OECD inventories down to the rolling five year average has been reached. Thus aim for moderate increase in 2H18, but increase more if needed.
Ch1: The oil price for emerging markets is just as high today as it was in 2011 to 2014
Thus demand destruction is naturally setting in at such a price level with weakness in demand as a result
Ch2: OPEC+ produced 2 m bl/d less in May than it did in October 2016
On average since the start of 2017 the group has delivered net cuts of 1.5 m bl/d and slightly less than the pledged 1.7 m bl/d
Ch3: But deliberate cuts were only 1.55 m bl/d while involuntary cuts amounted to 1.3 m bl/d
Market is starting to take US/Iran headlines with a pinch of salt. Brent crude rose $2.8/b yesterday to an official close of $112.1/b. But after that it traded as low as $108.05/b before ending late night at around $109.7/b. Through the day it traded in a range of $106.87 – 112.72/b amid a flurry of news or rumors from Iran and the US. ”US temporary sanctions during negotiations” (falls alarm). ”We will bomb Iran” (not anyhow),… etc. While the market is still fluctuating to this kind of news flow, it is starting to take such headlines with a pinch of salt.
We’ll see. Maybe, maybe not. The Brent M1 contract is trading at $110.2/b this morning which very close to the average ticks through yesterday of $110.4/b.
Trump with bearish, verbal intervention whenever Brent trades above $110/b it seems. What seems to be a pattern is that Trump states something like ”very good negotiations going on with Iran”, ”New leaders in Iran are great,..”, ”Great progress in negotiations,…”, ”Deal in sight,..” etc whenever the Brent M1 contract trades above $110/b. An effort to cool the market. These hot air verbal interventions from Trump used to have a heavy bearish impact on prices, but they now seems to have less and less effect unless they are backed by reality.
As far as we can see there has been no real progress in the negotiations between the US and Iran with both sides still standing by their previous demands.
Iran is getting stronger while the cease fire lasts making a return to war for Trump yet harder. Iran is naturally in constant preparation for a return to war given Trump’s steady threats of bombing Iran again. Iran is naturally doing what ever is possible to prepare for a return to war. And every day the cease fire lasts it is better prepared. This naturally makes it more and more difficult and dangerous for the US to return to warring activity versus Iran as the consequences for energy infrastructure in the Persian Gulf will be more and more severe the longer the cease fire lasts. Israel seems to see it this way as well. That the war is not won and that current frozen state of a cease fire gives Iran opportunity to rebuild military and politically.
Global inventories are drawing down day by day. How much? In the meantime the Strait of Hormuz stays closed. There is varying measures and estimates of how much global inventories are drawing down. Our rough estimate, back of the envelope, is that global inventories are drawing down by at least some 10 mb/d or about 300 mb/d in a balance between loss of supply versus demand destruction. Other estimates we see are a monthly draw of 250-270 mb/d. The IEA only ’measured’ a draw in global observable stocks of 117 mb in April with oil on water rising 53 mb while on shore stocks fell 170 mb. But global stocks are hard to measure with large invisible, unmeasured stocks. As such a back of the envelope approach may be better.
Oil products is what the world is consuming. Oil product prices likely to rise while product stocks fall. Strategic Petroleum Reserves (SPR) are predominantly crude oil. Discharging oil from OECD SPR stocks, a sharp reduction in Chinese crude imports and a reduction in global refinery throughput of 6-7 mb/d has helped to keep crude oil markets satisfactorily supplied. But global inventories are drawing down none the less. And oil products is really what the world is consuming. So if global refinery throughput stays subdued, then demand will eventually have to match the supply of oil products. The likely path forward this summer is a steady draw down in jet fuel, diesel and gasoline. Higher prices for these. Then, if possible, higher refinery throughput and higher usage of crude in response to very profitable refinery margins. And lastly sharper draw in crude stocks and higher prices for these. But some 6 mb/d of oil products used to be exported through the Strait of Hormuz. And it may not be so easy to ramp up refinery activity across the world to compensate. Especially as Ukraine continues to damage Russian refineries as well as Russian crude production and export facilities.
Watch oil product stocks and prices as well as Brent calendar 2027. What to watch for this summer is thus oil product inventories falling and oil product premiums to crude rising. Another measure to watch is the Brent crude 2027 contract as it rises steadily day by day as the Strait of Hormuz stays closed and global oil inventories decline. The latter is close to the highest level since the start of the war and keeps rising.
The Brent M1 contract and the Brent 2027 prices and current price of jet fuel in Europe (ARA). All in USD/b
Our back of the envelope calculation of the global shortage created by the closure of the Strait of Hormuz. Note that 3.5 mb/d of discharge from SPR is also a draw. Note also that ’Forced demand loss’ of 2.5 mb/d is probably temporary and will fall back towards zero as logistics are sorted out leaving ’Price demand loss’ to do the job of balancing the market. Thus a shortfall of at least 9 mb/d created by the closure. More if SPR discharge is included and more if Forced demand loss recedes.
Brent is climbing higher. Front-month is at USD 106.3/bl this morning, close to a weekly high and a USD 9/bl jump from Mondays open. This is the move we flagged as a risk earlier in the week: the market shifting from ”a deal is around the corner” to ”this is going to take longer than we thought”.
Analyst Commodities, SEB
During April, rest-of-year Brent remained remarkably stable around USD 90/bl. A stability which rested on one single assumption: the SoH reopens around 1 May. That assumption is now slowly falling apart.
As we highlighted yesterday: every week of delay beyond 1 May adds (theoretically) ish USD 5/bl to the rest-of-year average, as global inventories draw 100 million barrels per week. i.e., a mid-May reopening implies rest-of-year Brent closer to USD 100/bl, and anything pushing into June or July takes us meaningfully higher.
What’s changed in the last 48 hours:
#1: The US military has formally warned that clearing suspected sea mines from SoH could take up to six months. That is a completely different timescale from what the financial market is pricing. Even a political deal tomorrow does not immediately reopen the strait.
#2: Trump has shifted his tone from urgency to ”strategic patience”. In yesterday’s press conference: ”Don’t rush me… I want a great deal.” The market is reading this as a president no longer feeling pressured by timelines, with the naval blockade running in the background.
#3: So far, the military activity is escalating, not de-escalating. Axios reports Iran is laying more mines in SoH. The US 3rd carrier strike group (USS George H.W. Bush) is arriving with two countermine vessels. Trump yesterday ordered the US Navy to destroy any Iranian boats caught laying mines. While CNN reports that the Pentagon is actively drawing up plans to strike Iranian SoH capabilities and individual Iranian military leaders if the ceasefire collapses. i.e., NOT a attitude consistent with an imminent deal!
Spot crude and product prices eased off the early-April highs on a combination of system rerouting and deal optimism. Both now weakening. Goldman estimates April Gulf output is reduced by 14.5 mbl/d, or 57% of pre-war supply, a number that keeps getting worse the longer this drags on.
Demand-side adaptation is ongoing: S. Korea has cut its Middle East crude dependence from 69% to 56% by pulling more from the Americas and Africa, and Japan is kicking off a second round of SPR releases from 1 May. But SPRs are finite.
Ref. to the negotiations, we should not bet on speed. The current Iranian leadership is dominated by genuine hardliners willing to absorb economic pain and run the clock to extract concessions. That is not a setup for a rapid resolution. US/Israeli media briefings keep framing the delay as ”internal Iranian divisions”, the reality is more complicated and points toward weeks and months, not days.
Our point is that the complexity is large, and higher prices have only just started (given a scenario where the negotiations drag out in time). The market spent April leaning on the USD 90/bl rest-of-year assumption; that case is diminishing by the hour. If ”early May reopening” is replaced by ”June, July or later” over the next week or two, both crude and products have meaningful room to reprice higher from here. There is a high risk being short energy and betting on any immediate political resolution(!).
Down on Friday. Up on Monday. The Brent June crude oil contract traded down 5.1% last week to a close of $90.38/b. It reached a high of $103.87/b last Monday and a low of $86.09/b on Friday as Iran announced that the Strait of Hormuz was fully open for transit. That quickly changed over the weekend as the US upheld its blockade of Iranian oil exports while Iran naturally responded by closing the SoH again. The US blew a hole in the engine room of the Iranian ship TOUSKA and took custody of the ship on Sunday. Brent crude is up 5.6% this morning to $95.4/b.
The cease-fire is expiring tomorrow. The US has said it will send a delegation for a second round of negotiations in Islamabad in Pakistan. But Iran has for now rejected a second round of talks as it views US demands as unrealistic and excessive while the US is also blocking the Strait of Hormuz.
While Brent is up 5% this morning, the financial market is still very optimistic that progress will be made. That talks will continue and that the SoH will fully open by the start of May which is consistent with a rest-of-year average Brent crude oil price of around $90/b with the market now trading that balance at around $88/b.
Financial optimism vs. physical deterioration. We have a divergence where the financial market is trading negotiations, improvements and resolution while at the same time the physical market is deteriorating day by day. Physical oil flows remain constrained by disrupted flows, longer voyage times and elevated freight and insurance costs.
Financial markets are betting that a US/Iranian resolution will save us in time from violent shortages down the road. But every day that the SoH remains closed is bringing us closer to a potentially very painful point of shortages and much higher prices.
The US blockade is also a weapon of leverage against its European and Asian allies. When Iran closed the SoH it held the world economy as a hostage against the US. The US blockade of the SoH is of course blocking Iranian oil exports. But it is also an action of disruption directed towards Europe and Asia. The US has called for the rest of the world to engaged in the war with Iran: ”If you want oil from the Persian Gulf, then go and get it”. A risk is that the US plays brinkmanship with the global oil market directed towards its European and Asian allies and maybe even towards China to force them to engage and take part. Maybe unthinkable. But unthinkable has become the norm with Trump in the White House.
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