Analys
High risk for repeated attacks. Bearish concerns overstated
For two days in a row the Brent crude oil price has traded quite hard to the downside during intra-day trading before kicking back up again towards the close. A lot of the gains following the attacks on Saudi oil infrastructure almost two weeks ago have now been given back. Brent closed at $60.22/bl on Friday 13 September just before the attacks. Though having given back a lot of its gains (it spiked to $71.95/bl on Monday Sep 16) Brent has struggled to close below the $62/bl line.
What is notable is that following the Brent low close of $56.23/bl on 7 August Brent has been on a gradual trend higher irrespective of the attacks on Saudi Arabia. This matches well with the fact that US crude oil stocks declined by 70 million barrels from early July to early September.
The global oil market now seems to be so accustomed to living in oil affluence since 2014 that not even a damaging attack at the heart of the global oil market is able unnerve the market much with oil prices now just a tiny bit higher than before the attacks. Real action, real physical tightness in the spot market is probably what is needed to pull the market out of its current complacency.
The market is now “bean-counting” how much oil is lost from the attacks. What really matters in our view is the repetition risk for new attacks. In our view this risk is very high but there is hardly any risk premium in the market for this as we can see.
The front-end of the Brent crude oil curve has been in backwardation continuously since early this year signalling a draw-down in crude oil inventories and a tight front-end crude oil market. This tightness has not manifested itself as elevated flat prices as the whole crude oil curve has been pushed down by bearish bearish sentiment for the global oil market balance for next year amid slowing global growth, strong non-OPEC production growth projections for 2020 and doubts over the abilities and willingness of OPEC+ to cut yet deeper if needed.
The global oil market is unlikely to run a 1 m bl/d surplus in 2020 due to IMO-2020 (barring a global recession). We do share some of the markets bearish concerns for next year, but we do not agree with all of them and we do not agree with the conclusion of many oil market balance forecasts for next year being strongly in surplus with need of further cuts by OPEC+ to prevent a strong rise in OECD stocks. And neither do we agree with the view that OPEC+ has its back against the wall and has lost so much oil production volume to booming US shale oil production that it has now basically run out of bullets with little capacity to cut further if needed.
One key element in the global oil market balance next year in our view is the IMO-2020 sulphur bunker oil regulations. We have worked on this issue extensively over the past three years and written numerous reports on the subject. It is of course a hot topic and almost everyone who is writing about oil has nowadays written a report about it. What puzzles us is that as far as we can see no one accounts for the IMO-2020 event in their supply/demand balances for 2020. We have at least not seen any specific IMO-2020 line item in any of the balances we have seen.
As a consequence of the IMO-2020 regulations our base assumption is that a ballpark 1 m bl/d of high sulphur residue / bunker oil will be barred from legal use in global transportation. It will either be burned for heat, power or be stored. Typical HFO 3.5% bunker demand today is 3.5 m bl/d. Legal plus cheating demand in global shipping in 2020 will likely be about 1 m bl/d. Our guestimate is that some 1.5 m bl/d will be converted and transformed in refineries to other compliant products.
So in our view the IMO-2020 effect will put about 1 m bl/d of high sulphur residue /bunker oil on the side-line of the global transportation market. This is a clear and straight forward tightening of the global liquids market. The global transportation market thus needs an additional 1 m bl/d of hydrocarbon liquids from other sources instead. That is the IMO-2020 tightening we expect to see and we cannot identify such an IMO-2020 item in the supply/demand balances anywhere else in the market.
Everybody talks about the adverse impact the IMO-2020 will have on the global oil market, but no one takes account of it in any way in their supply/demand balances. Thus everyone sees a 1 m bl/d surplus for 2020 instead of a balanced market as we do.
OPEC+ has not run out of bullets. The key producers are instead producing close to all-time-high or 5yr averages. A key assumption in the market’s highly bearish concerns for next year is the assumption that “OPEC+ has run out of bullets” with no ability or appetite to cut deeper if needed. “They are cutting and cutting but are not able to get the oil price higher” is the market’s view of OPEC+ currently. It is true that production from the group has fallen sharply but that is primarily due to the sharp involuntary losses from Iran, Venezuela and Mexico. The key players being Russia, Kuwait, Iraq, UAE and Saudi Arabia are however producing either close to all-time-high levels or normal averages. They have hardly given away a single barrel.
Apparently Saudi Arabia has been cutting deep and delivered much deeper cuts than what it has been obliged to according to the agreement at the end of last year. But Saudi Arabia is to a large degree just playing with our minds and views. Saudi Arabia boosted production from 9.9 m bl/d in March 2018 to a monthly high of 11.1 m bl/d in November 2018 and then agreed to cut from that level down to 10.5 m bl/d. As such its production 9.8 m bl/d in August seems like a deep cut and over-compliance. Saudi Arabia’s average production over the past 60 months was 10.15 m bl/d. So Saudi Arabia produced only 0.3 m bl/d below its 5 yr average in August.
Our view is thus that the key players with control over their production have not at all given away much volume to booming US shale oil production and are fully in a position to cut more if needed or if they decide to do so.
High speed to Saudi Aramco IPO = high oil price volatility and elevated risks for renewed attacks. Saudi Aramco is now pushing hard to speed up the Aramco IPO at least for its partial and initial listing in Saudi Arabia. Research teams from the world’s largest financial institutions are now working around the clock to finalize draft assessments by mid-October. An as of yet non-published time-schedule of the IPO has it that Saudi Aramco will announce its IPO-plans on October 20th.
The recent attack on Saudi Arabia’s oil infrastructure is in our view just the last attack in a line of many. The attack has made it very clear that Saudi Arabia’s oil infrastructure is highly vulnerable and that it is very difficult to protect against attacks of the character two weeks ago. The weapons used were probably fairly low cost but had high precision and can be launched from almost anywhere. The attackers have detailed information of Saudi Arabia’s oil infrastructure and obviously also understands where to attack with high precision in order to make maximum damage with relatively small explosives.
It is clear that the market will managed and overcome the latest damages and supply outage in Saudi Arabia and repairs will be done. It will however draw down global inventories further and reduce Saudi spare capacity for several months to come. We do however think that the risk for repetitions of the latest attack is very, very high unless source of the reason for the attack is solved. I.e. the Iran and Yemen issues need to be resolved and defused. As long as those issues are not resolved we expect renewed attacks to take place. Especially so in the run-up to the Saudi Aramco IPO as it will have a negative effect on the listing in our view.
Strengthening cracks on refinery runs, Saudi attack and IMO-2020. US refineries are now reducing runs and crude consumption in the weeks to come until they ramp up again in mid-October. Thus US crude inventories are likely to rise (as we saw in this week’s data release) while product inventories are likely to decline along seasonal trends. This is likely to put strength to oil product cracks. Saudi Arabia has also imported oil products from the global market in order to compensate for domestically reduced refinery runs which also add strength to product cracks. The IMO-2020 switch-over is also moving closer and closer and we expect a very strong transitional Gasoil demand from the global shipping market in Q4-19 and Q1-20 just as we move through the Nordic hemisphere heating season peak. We see significant upside price risk for gasoil cracks in those two quarters. We think it is just a matter of time before much stronger mid-dist cracks kicks in fully in the spot market with a bullish effect rippling down the forward crack curve.
In sum: Bearish risks for 2020 are overstated
Bullishly:
- IMO-2020 will have a tightening effect of about 1 m bl/d
- OPEC+ has not run out of bullets
- High risk for repeated attacks and damages on Saudi Arabia oil infrastructure. Especially in the IPO run-up
Bearishly:
- A global recession if it materializes would have a strong bearish impact on oil prices and market
- A return of supply from Venezuela and/or Iran are clear bearish risks but we hold low probabilities for this
We expect Brent crude to average:
- 2020: $70/bl
- 2021: $70/bl
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.
Oil product price pain is set to rise as the Strait of Hormuz stays closed into summer
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