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More oil from OPEC+ is the base case

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SEB - Prognoser på råvaror - CommoditySaudi Arabia and Russia have already started to lift production and are arguing for an increase in production at the upcoming OPEC+ meeting next week. Unofficial sources have said that Russia will propose to return production back to the October 2016, i.e. removing the cap altogether over a period of three months. The countries who do not have any capacity to increase production are naturally opposing any suggestion of an end to the current cap as they will have no gain from higher production and just face a loss due to a relatively lower price due to production increases by the others. So Iran, Iraq and Venezuela are all opposing any removal of the cap. We think there is no way around an increase in production by Russia and Saudi Arabia. It does not make sense to risk an overly tight oil market in 2H18 just when global economic growth is cooling down with 16 of the world’s largest financial institutions having moved into bear market in a sign that higher interest rates, a stronger USD and higher oil prices are problematic for the global economy. It makes no sense for Saudi Arabia to break the OPEC+ cooperation either as it will likely be needed at another occasion further down the road. The challenge at next week’s OPEC+ meeting will thus be how to formulate a proposal for a gradual revival of production which all members can sign on to.

Bjarne Schieldrop, Chief analyst commodities at SEB

Bjarne Schieldrop, Chief analyst commodities

Price action: Ticking lower with more production from OPEC+ on the horizon

Brent crude fell back 0.8% to $75.88/bl with the longer dated contracts down almost as much as the Dec-2021 contract settled 0.6% lower at $65.94/bl. The WTI benchmark however gained 0.4% to $66.36/bl thus leading to a narrowing of the spread which blew out lately. The Brent to Midland (Permian) WTI spread narrowed to $17.9/bl having recently been trading as wide as $22.0/bl. This morning Brent pulls back another 0.3% to $75.64/bl as production revival by OPEC+ next week seems more and more like the most likely outcome.

OPEC’s MOMR report yesterday contains ammunition for those in OPEC+ who do not want a production revival

OPEC’s monthly oil market report yesterday was somewhat confusing. At the start of the report it highlighted significant uncertainty for Call-on-OPEC for 2H18. It set an uncertainty range of 1.8 m bl/d with a span from 31.5 m bl/d to 33.3 m bl/d and a mean expectation of 32.1 m bl/d. In its supply/demand balance later in the report it still set forecasted a call-on-OPEC at 33.3 m bl/d for 2H18, i.e. at the absolute high end of its uncertainty range highlighted at the start of its report. There must obviously have been some considerable disagreement between different writers participating in the writing of the report. As the report said in the Feature Article “World oil market prospects for the second half of 2018”: “Given the Secretariat’s forecast for 2H18, demand for OPEC crude is projected at 33.3 m bl/d..” Thus the Secretariat seems to have more or less dictated what the official Call-on-OPEC for 2H18 should be thus overruling the analysis that the mean expected call-on-OPEC for 2H18 was projected at 32.1 m bl/d. Or it is basically just two separate pieces of analysis.

OPEC produced 32.1 m bl/d on average from January to May. Thus according to the average forecasted sensitivity analysis in OPEC’s latest MOMR report in the Feature Article there is no room for any increase in production from OPEC in 2H18. Keeping production at current level of about 32.0 would actually keep the market at a neutral balance though OECD. The story in the MOMR Feature Article is thus strong ammunition for all those in the OPEC+ group who are arguing that production should not be lifted from the current production level. Production in Venezuela is of course declining by 50 k bl/d MoM and Iran’s production is likely going to decline a little as well. There is thus obviously some room to increase production by some of the other members in order to compensate for this. The caps set in Nov-2016 are however individual caps so increasing production by Saudi Arabia and Russia in order to compensate for lost supply in Venezuela and possibly Iran needs a vote.

Uncertainty for Call-On-OPEC in 2H18 clearly warrants serious attention. While US consumer confidence is ticking higher the JPMorgan global PMI manufacturing index has ticked lower and lower since its peak in December last year even though it is still in positive territory of 53.1. Global growth has definitely cooled in 1H18. At the moment it does not seems as if a booming US economy is able to drag the rest of the world with it. Rather it seems like higher interest rates, a stronger USD and a higher oil price increasingly is creating a headwind for the global economy. The story in the FT today that 16 large global financial companies are down more than 20% from their peaks is highlighting the fact that the global economy is having a problem swallowing higher interest rates, stronger dollar and more expensive oil.

We expect OPEC+ to decide next week to increase production by 0.5 m bl/d in 2H18 at a gradual and measured pace.

 US consumers are getting happier but the world’s manufacturers are not

Global manufacturing PMI’s usually do relate well with Bloomberg’s Energy commodity index

Ch3: Solid OECD inventory decline in April if adjusting for normal seasonal trendsThe OECD inventories declined

MoM by 3.1 million barrels in April. However, inventories normally rise by 26 million barrels in April. So versus seasonal trends the OECD inventories fell 28.6 million barrels in April which is equal to a seasonally adjusted deficit of 0.95 m bl/d.

Solid OECD inventory decline in April if adjusting for normal seasonal trends

Analys

Tightening fundamentals – bullish inventories from DOE

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The latest weekly report from the US DOE showed a substantial drawdown across key petroleum categories, adding more upside potential to the fundamental picture.

Ole R. Hvalbye, Analyst Commodities, SEB
Ole R. Hvalbye, Analyst Commodities, SEB

Commercial crude inventories (excl. SPR) fell by 5.8 million barrels, bringing total inventories down to 415.1 million barrels. Now sitting 11% below the five-year seasonal norm and placed in the lowest 2015-2022 range (see picture below).

Product inventories also tightened further last week. Gasoline inventories declined by 2.1 million barrels, with reductions seen in both finished gasoline and blending components. Current gasoline levels are about 3% below the five-year average for this time of year.

Among products, the most notable move came in diesel, where inventories dropped by almost 4.1 million barrels, deepening the deficit to around 20% below seasonal norms – continuing to underscore the persistent supply tightness in diesel markets.

The only area of inventory growth was in propane/propylene, which posted a significant 5.1-million-barrel build and now stands 9% above the five-year average.

Total commercial petroleum inventories (crude plus refined products) declined by 4.2 million barrels on the week, reinforcing the overall tightening of US crude and products.

US DOE, inventories, change in million barrels per week
US crude inventories excl. SPR in million barrels
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Analys

Bombs to ”ceasefire” in hours – Brent below $70

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A classic case of “buy the rumor, sell the news” played out in oil markets, as Brent crude has dropped sharply – down nearly USD 10 per barrel since yesterday evening – following Iran’s retaliatory strike on a U.S. air base in Qatar. The immediate reaction was: “That was it?” The strike followed a carefully calibrated, non-escalatory playbook, avoiding direct threats to energy infrastructure or disruption of shipping through the Strait of Hormuz – thus calming worst-case fears.

Ole R. Hvalbye, Analyst Commodities, SEB
Ole R. Hvalbye, Analyst Commodities, SEB

After Monday morning’s sharp spike to USD 81.4 per barrel, triggered by the U.S. bombing of Iranian nuclear facilities, oil prices drifted sideways in anticipation of a potential Iranian response. That response came with advance warning and caused limited physical damage. Early this morning, both the U.S. President and Iranian state media announced a ceasefire, effectively placing a lid on the immediate conflict risk – at least for now.

As a result, Brent crude has now fallen by a total of USD 12 from Monday’s peak, currently trading around USD 69 per barrel.

Looking beyond geopolitics, the market will now shift its focus to the upcoming OPEC+ meeting in early July. Saudi Arabia’s decision to increase output earlier this year – despite falling prices – has drawn renewed attention considering recent developments. Some suggest this was a response to U.S. pressure to offset potential Iranian supply losses.

However, consensus is that the move was driven more by internal OPEC+ dynamics. After years of curbing production to support prices, Riyadh had grown frustrated with quota-busting by several members (notably Kazakhstan). With Saudi Arabia cutting up to 2 million barrels per day – roughly 2% of global supply – returns were diminishing, and the risk of losing market share was rising. The production increase is widely seen as an effort to reassert leadership and restore discipline within the group.

That said, the FT recently stated that, the Saudis remain wary of past missteps. In 2018, Riyadh ramped up output at Trump’s request ahead of Iran sanctions, only to see prices collapse when the U.S. granted broad waivers – triggering oversupply. Officials have reportedly made it clear they don’t intend to repeat that mistake.

The recent visit by President Trump to Saudi Arabia, which included agreements on AI, defense, and nuclear cooperation, suggests a broader strategic alignment. This has fueled speculation about a quiet “pump-for-politics” deal behind recent production moves.

Looking ahead, oil prices have now retraced the entire rally sparked by the June 13 Israel–Iran escalation. This retreat provides more political and policy space for both the U.S. and Saudi Arabia. Specifically, it makes it easier for Riyadh to scale back its three recent production hikes of 411,000 barrels each, potentially returning to more moderate increases of 137,000 barrels for August and September.

In short: with no major loss of Iranian supply to the market, OPEC+ – led by Saudi Arabia – no longer needs to compensate for a disruption that hasn’t materialized, especially not to please the U.S. at the cost of its own market strategy. As the Saudis themselves have signaled, they are unlikely to repeat previous mistakes.

Conclusion: With Brent now in the high USD 60s, buying oil looks fundamentally justified. The geopolitical premium has deflated, but tensions between Israel and Iran remain unresolved – and the risk of missteps and renewed escalation still lingers. In fact, even this morning, reports have emerged of renewed missile fire despite the declared “truce.” The path forward may be calmer – but it is far from stable.

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Analys

A muted price reaction. Market looks relaxed, but it is still on edge waiting for what Iran will do

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Brent crossed the 80-line this morning but quickly fell back assigning limited probability for Iran choosing to close the Strait of Hormuz. Brent traded in a range of USD 70.56 – 79.04/b last week as the market fluctuated between ”Iran wants a deal” and ”US is about to attack Iran”. At the end of the week though, Donald Trump managed to convince markets (and probably also Iran) that he would make a decision within two weeks. I.e. no imminent attack. Previously when when he has talked about ”making a decision within two weeks” he has often ended up doing nothing in the end. The oil market relaxed as a result and the week ended at USD 77.01/b which is just USD 6/b above the year to date average of USD 71/b.

Bjarne Schieldrop, Chief analyst commodities, SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

Brent jumped to USD 81.4/b this morning, the highest since mid-January, but then quickly fell back to a current price of USD 78.2/b which is only up 1.5% versus the close on Friday. As such the market is pricing a fairly low probability that Iran will actually close the Strait of Hormuz. Probably because it will hurt Iranian oil exports as well as the global oil market.

It was however all smoke and mirrors. Deception. The US attacked Iran on Saturday. The attack involved 125 warplanes, submarines and surface warships and 14 bunker buster bombs were dropped on Iranian nuclear sites including Fordow, Natanz and Isfahan. In response the Iranian Parliament voted in support of closing the Strait of Hormuz where some 17 mb of crude and products is transported to the global market every day plus significant volumes of LNG. This is however merely an advise to the Supreme leader Ayatollah Ali Khamenei and the Supreme National Security Council which sits with the final and actual decision.

No supply of oil is lost yet. It is about the risk of Iran closing the Strait of Hormuz or not. So far not a single drop of oil supply has been lost to the global market. The price at the moment is all about the assessed risk of loss of supply. Will Iran choose to choke of the Strait of Hormuz or not? That is the big question. It would be painful for US consumers, for Donald Trump’s voter base, for the global economy but also for Iran and its population which relies on oil exports and income from selling oil out of that Strait as well. As such it is not a no-brainer choice for Iran to close the Strait for oil exports. And looking at the il price this morning it is clear that the oil market doesn’t assign a very high probability of it happening. It is however probably well within the capability of Iran to close the Strait off with rockets, mines, air-drones and possibly sea-drones. Just look at how Ukraine has been able to control and damage the Russian Black Sea fleet.

What to do about the highly enriched uranium which has gone missing? While the US and Israel can celebrate their destruction of Iranian nuclear facilities they are also scratching their heads over what to do with the lost Iranian nuclear material. Iran had 408 kg of highly enriched uranium (IAEA). Almost weapons grade. Enough for some 10 nuclear warheads. It seems to have been transported out of Fordow before the attack this weekend. 

The market is still on edge. USD 80-something/b seems sensible while we wait. The oil market reaction to this weekend’s events is very muted so far. The market is still on edge awaiting what Iran will do. Because Iran will do something. But what and when? An oil price of 80-something seems like a sensible level until something do happen.

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