Analys
Iraqi oil production and exports at stake
The Brent crude oil price spiked 3.6% on Friday to $68.6/bl on the back of the US killing of the Iranian general Qassem Soleimani. This morning it jumps 2.3% to $70.2/bl. Though so far not a single drop of oil supply has been lost.
Iranian retaliation and then US re-retaliation are however imminent. The US has already pre-selected 52 Iranian targets. Eventual loss of supply in the Middle East may however be in Iraq down the road and not so much due to near term retaliations.
US forces in Iraq now seem likely to be kicked out of the country and Iraq will then most likely “fall into the arms of Iran”. As former acting head of the CIA, Michael Morell, put it: “I think we’ve now ended any hope of keeping Iraq out of Iran’s arms.”
If Iran and Iraq become one large Shia Muslim centre of gravity in the Middle East, then US sanctions towards Iran would naturally be extended also to Iraq leading to a decline in Iraqi oil production and exports. This now looks very much like the way it is moving. The U.S. president on Sunday threatened to impose sanctions on Iraq if the Iraqi parliament voted to expel US troops from the country.
It is very clear that if it wasn’t for the fact that the oil market lost more than 3 m bl/d of crude oil supply from Iran and Venezuela since the end of 2016 it would not have been possible for the US to grow its crude oil production by more than 4 m bl/d over the same period and thus become oil independent and still have an oil price today of more than $60/bl. It is also quite clear that the lost supply from Iran and Venezuela to a large degree is the result of US sanctions towards these two nations and that these sanctions basically have paved the way for US oil production growth and oil independence.
It would of course be very bearish for the oil market if supplies from Iran and Venezuela came back into the market. That will probably happen at some point in time. However, we do not think that this will happen any time soon (years). Production and exports from these two countries will most likely be kept out of the market as long as the US needs room to grow its oil production and exports. The more correct focus may instead be to ask who is next in line to be kicked out of the oil market in order to make room for growing US oil production and exports? Right now, it seems likely to be Iraq.
It might be a tall order to accuse Donald Trump of such simple mercantile motives. But we need look no further than to the Russian gas pipeline Nord Stream 2 which stretches from Ust-Luga in Russia through the Baltic Sea and to Greifswald in Germany. In December the U.S. Senate imposed sanctions on companies working on the pipeline in order to prevent it from being completed. Their explanation was that they did it to protect Europe from becoming too dependent on Russian gas exports. But the sanctions are against the will of the EU. As such this looks bluntly as a move by the U.S. to prevent Russian gas flowing to the EU thus making room for growing U.S. gas exports to Europe instead.
The situation for Iran is of course extremely difficult. Donald Trump basically killed on of its highest-ranking generals with a precision drone high in the sky while he was playing golf at his resort in Florida (or at least he was at his resort there). The feeling of helplessness must be pervasive. If Iran now retaliates and kills U.S. armed forces (which seems likely) they will just see more devastating retaliations in return. The only real hope for Iran it seems is if they could get China fully over to their side and ramp up oil exports to China. While China wants its oil it most likely won’t go in the face of the U.S. doing so in large volumes. But if Iranian sanctions are extended also to Iraq it could be different.
Our general view for 2020 is that there will be involuntary losses of supply in the middle east in the year to come. Either through military action like the one in September when Saudi Arabian oil production was cut in half by the drone strike at its Abqaiq oil reprocessing plant or increased U.S. sanctions for example towards Iraq. The Iranian situation was probably the key source of the disruptive events in the middle east in 2019. This “source problem” has now just become much worse. The consequence of these “most likely losses of supply to come” in the middle east will be that the oil price will be elevated, global oil surplus will be avoided, and U.S. oil production growth and exports can re-accelerate again.
Ch1: Cumulative oil production change in the U.S. versus Iran + Venezuela. U.S. production growth would not have been possible without the losses of supplies from Iran and Venezuela and those losses were largely due to sanctions from the U.S.
Ch2: Crude oil production in m bl/d in the US, Iran, Iraq and Venezuela
Ch3: Iraq and Iran might be a large Shia Muslim force if Iraq now votes to expel U.S. troops. The U.S. on Sunday threatened Iraq with sanctions if U.S. troops are expelled.
Ch4: The EU wants gas from Russia via the new Nord Stream 2 pipeline. The U.S. doesn’t want it. It want’s to export gas to the EU
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.
Sommarväder skapar prisrally på elbörsen
Oil product price pain is set to rise as the Strait of Hormuz stays closed into summer
Solkraften pressar elpriserna dagtid
Michel Gubel ger sin syn på oljemarknaden