Analys
Iran – Reactive Saudi means price will tick higher
Saudi Arabia pre-emptively and proactively lifted oil production last year in anticipation of US sanctions towards Iran. Sanctions were supposed to be more or less “cold turkey” starting November last year but Donald caved in and handed out a large portion of waivers. The result was that the pre-emptive production increase by OPEC+ last year instead managed to crash the oil price down to below $50/bl. Saudi Arabia is unlikely to make the same mistake again and is in our view likely to be reactive this time. First see how much oil supply is really lost and then increase production according to needs.
That means that the oil price is likely going to continue on its current bull-ride for a while before Saudi Arabia (++) decides to pitch in with substantially more production.
Iran probably exported about 2 m bl/d in March according to tanker tracker news. That is down 1 m bl/d from one year ago when they exported about 3.0 m bl/d liquids.
South Korea, India, Japan imported 0.75 m bl/d in March. They are likely going to comply fully so that their imports will likely fall to close to zero in May/June.
China imported 0.61 m bl/d in March versus waivers allowed by the US of 0.36 m bl/d. China has strongly opposed the US sanctions towards Iran: “The US is reaching beyond its jurisdiction” and “Our cooperation with Iran is open, transparent, lawful and legitimate”. We think that China can’t and won’t back down this time and that we could easily see an increase of Chinese oil imports from Iran up towards maybe 1.0 m bl/d
China Iran oil imports to increase and more Iran oil under the radar. There will also be an increasing amount of oil exports out of Iran which will go “under the sanctions radar”. This could probably amount to some 0.5 m bl/d and were probably already standing at around 0.3 m bl/d in March. So if China lifts imports from 0.6 m bl/d in March to instead 1.0 m bl/d and “under the radar” exports increase from 0.3 m bl/d in March to instead 0.5 m bl/d then Iran oil exports will continue at around 1.5 m bl/d versus around 2.0 m bl/d in March
Increasing collision course between the US and China. The “cold turkey” Iran sanctions from the US will force China to decide what to do, to hold its turf and claim its right to import oil from Iran. It will drive Iran closer to China and enable China to settle yet more oil in renminbi.
Russia is unlikely to hold back production in 2H-19. It reduced its production by some 0.2 m bl/d to 11.3 m bl/d in March in order to comply with the OPEC+ agreement from early December. It’ll probably lift production back up to 11.5 m bl/d in 2H-19 and then tick higher. It has been sensibly reluctant to pre-emptively promise to hold back production in 2H-19 and stated very clearly that it’ll manage production according to circumstances and that these circumstances will be evaluated when they meet with OPEC+ in Vienna in June 25/26.
Russian willingness to cut probably vanishes around $65/bl. Saudi Arabia would happily see the oil price back up at $85/bl. Russia’s willingness to cut in order to support the oil price probably vanishes around $65/bl. Russia is all-in joining Saudi Arabia on production cuts in times of surplus, rising stocks and Brent below $50/bl. It has however communicated very clearly that it is not all too eager to hold the oil price much above $65/bl as it will boost shale oil investments and production. That is alright as long as we are losing more and more supply from Iran and Venezuela. But what if those supplies come back into the market while US shale production growth is booming at the same time? Thus better to be safe than sorry and keep the oil price at around $65/bl and US shale oil activity at medium temperature.
The market will lose some 0.5 – 1.0 m bl/d. We cannot really know how much supply will now be lost from Iran. We don’t think it will go to zero but rather that exports will decline from 2.0 m bl/d in March to instead some 1.0 – 1.5 m bl/d along with increasing imports by China and “unknowns”. I.e. the market will lose some 0.5 – 1.0 m bl/d. OPEC+ can easily adjust for this. Saudi Arabia could actually do it alone.
Saudi Arabia (OPEC+) in very good control of the market. OPEC+ in general and Saudi Arabia specifically will have a very good handle of the supply situation of the oil market. I.e. Saudi will put current cuts partially back into the market and can then cut again at a later time instead.
John Bolton aiming for Iran regime shift. It has been stated that Donald Trump does not know what he want to achieve in the Middle East but that John Bolton does: a regime shift. The zero waivers is a victory for John Bolton’s politics. It increases the risk for turmoil in the Middle East.
A higher oil price is good for the US. Donald Trump has for a long time tried to aim for a low oil price in support of the US consumer and his core voters. His economic advisors have however this spring argued that a high oil price is now increasingly positive for the US economy as a whole as it is now increasingly becoming a net oil exporter. The negative for the consumers is increasingly outweighed by the positives for the oil producers. Thus Donald going for no waivers means that Donald is now increasingly siding with the producers rather than the consumers.
A more fragile oil market balance and yet more supply from the US. Less oil from Iran and a higher oil price means more US shale oil drilling and more supply growth from the US. But we are also getting a more fragile oil market. Supply from Venezuela continues to decline while supply from Libya and Nigeria is unstable as well.
Crude quality matters – IMO 2020 and diesel. Global oil supply is losing more and more medium to heavy sour crude oil which instead is largely replaced by ultralight US shale oil supply. The former is rich on medium to heavy molecule chains where the heavy chains can be converted to medium. The ultralight is rich on gasoline and light products which cannot be converted to medium elements. Medium elements mean Diesel, Gasoil and Jet fuel. Due to new fuel regulations in global shipping from 1 January 2020 the global shipping fleet will consume a lot more diesel/Gasoil like molecules. So less supply of diesel/Gasoil rich crudes but more demand means yet stronger mid-dist cracks.
Medium sour crude is typically the crude Saudi Arabia and OPEC and Russia. So if the world is craving for more Diesel, Gasoil and Jet fuel it is also craving for more of this crude. It means that Saudi Arabia and Russia (and OPEC) are in very good control of the oil market, even better than headline numbers indicate due to quality issues.
Ch1: Iran consumes some 1.7 m bl/d. In addition to 2.7 m bl/d of crude production in March 2019 it probably also produced some 0.95 m bl/d of condensates with total production of liquids of about 3.65 m bl/d. Exports thus probably stood at around 2.0 m bl/d in March which is also what tanker tracker data indicates. Exports are probably going to decline to about 1.0 to 1.5 m bl/d in May June
Ch2: Implied Iran hydro carbon liquids exports in m bl/d. US IEA data up to Sep 2018. Last data point estimated by SEB
Ch3: Saudi Arabia, UAE and Russia can easily lift production by 1.5 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.
Oil product price pain is set to rise as the Strait of Hormuz stays closed into summer
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