Analys
Trade war and Nopec-shake, but market looks like tightening
Brent crude sold off 1.7% yesterday with a close of $61.63/bl but has rebounded 0.4% today trading at $61.8/bl. The sell-off came on the back of a 0.9% decline in S&P 500 and a marginally stronger dollar with DXY now just 0.9% below the highs from late 2018. The clear driver for the sell-off in both crude and equities was the signal from Donald Trump that there will be no trade deal between China and the US before the March 1 deadline runs out. The consequence of this is that tariffs on about $200bn worth of goods from China will increase from 10% to 25% from March 1. It definitely took the air out of growth hopes both for economics and for oil.
Bjarne Schieldrop, Chief analyst commodities, SEB
US Nopec legislation (“No Oil Producing and Exporting Cartels Act 2019”) moved forward in the US. The bill was approved by the House judiciary committee on Thursday and is now ready for a full House vote. It will also need to be approved by the US Senate. Given Donald Trump’s known hostile stance towards OPEC it now looks like a very good chance that the bill will actually be voted through without being vetoed down by the President (George W Bush did that last time the bill was promoted). The prospect of a passage of Nopec legislation has added bearish pressure to Brent crude.
We don’t think that OPEC intervention matters all that much in the medium to longer term. After all, it is not low cost OPEC oil which sets the marginal cost of oil in the global market. It is the higher non-OPEC marginal cost which sets the global oil price over time. OPEC can never escape from this fact.
OPEC intervention is however a very important short term oil price driver. It is no doubt that the boost in production by OPEC+ from May to November last year helped to drown the global market in oil and crash the oil price from October to December. It is likewise just as clear that the revival in oil prices since December low of just below $50/bl to a recent high of $63.63/bl has the fingerprint of production cuts agreed by OPEC+ in December all over it.
So if the US Nopec legislation is voted through and becomes law it could definitely be bearish for oil prices right here and now given that OPEC+ is in the midst of tactical production cuts right this moment. The Nopec law will enable the US to prosecute OPEC members for price manipulation and potentially confiscate oil assets in the US belonging to such OPEC members. Whether OPEC members in general and Saudi Arabia specifically would cave in if Nopec becomes law remains to be seen. Qatar however left OPEC in December after 57 years in the group presumably due to the risk of Nopec becoming law.
It is Saudi Arabia which really is the captain of the OPEC ship. It is also Saudi Arabia who really moves supply up and down and moves the market with the other members just pitching in a little. The Nopec legislation could end tactical, cooperative production cuts and increases orchestrated by OPEC. It should probably not hinder Saudi Arabia to move production up and down on its own in order to address tactical turns and imbalances in the global oil market.
The Nopec legislation is however right in the face of Saudi Arabia. If Nopec becomes law it must be very damaging to the long lasting relationship between the US and Saudi Arabia. How can they go on being best palls if the US kills off OPEC as an organisation we wonder? This may be the next step in the geopolitical changes taking place in the Middle East. The US needs the Middle East less due to close to self-sufficiency of oil. China and India needs it more and more along with their rapidly rising oil imports and Russia is eager to get closer ties and influence in the region. Thus geopolitical changes could be the biggest fall-out.
OPEC’s true value strategy is not primarily about holding back supply tactically from existing production capacity from time to time even though this is primarily what the oil market is focusing on. The true strategy for OPEC is to make sure that they do not over-invest in their own low cost oil assets over time. It is about making sure that the global oil price balances on the higher non-OPEC marginal cost and not through over-investments within OPEC ends up balancing on low cost OPEC oil.
Thus OPEC needs to make sure that if global oil demand grows with some 1.4 m bl/d per year, then production growth from OPEC should be materially less than that. Achieving that is not about holding back production in existing capacity. It is about making sure that upstream investments in OPEC are not too high. The true OPEC strategy is thus about investment discipline over time and not about production discipline from existing capacity. On this more strategic issue it is not so clear that Nopec legislation will have all that much impact.
The amount of fossil fuels in the world is in a human perspective more or less infinite. It is all over the place. We are not running out. The price of oil is about how much oil we have above ground and not about how much is in the ground. Thus discipline on investments is OPEC’s true strategy.
As of right now OPEC+ continues to firm up the global market with its tactical tightening agreed upon in December. In addition we are losing volumes in Venezuela and Iran while general Haftar is fighting over the Sharara oil field in Libya.
Our view is that the situation in Venezuela will get worse before it gets better. US sanctions are biting and a visible reflection of that could be the softer shipping rates for Caribbean to the US Gulf trades since early January. I.e. it looks like shipments of oil out of Venezuela are declining further due to US sanctions. There may be a regime shift from Maduro to Guaido sometime in the future but we find it hard to imagine that Maduro will give up easily as he is backed by China and Russia. Even after a potential shift it will take time to revive confidence to international investors (debt holders) and oil service companies as well as all the oil service personnel which has fled the country. Money, people, competence and companies needs to move back to the country and then the oil industry needs to be revived. It is hard to see a strong revival in oil production in Venezuela this year.
Iran is definitely a sad, sad story and US shale oil production boom is bad, bad news for the Iran. Donald Trump handed out handsome oil import waivers to international buyers in Q4-18 in order to avoid a spike in the oil price. However, every additional barrel of oil produced in the US enables the US to reduce the Iran waivers just as much. Thus the more you are bullish US crude production, the more you should expect to see further declines in Iran oil exports along with smaller and smaller US waivers being handed out. Thus more US oil probably means comparably less oil out of Iran. Unfortunately for Iran.
The global economy is of great concern with continued US-China trade war (no resolution by March 1) and weakening outlook in general driving the outlook for global oil demand growth in 2019 lower. Global refining margins have moved down to very weak and painful levels at which refineries becomes increasingly likely to reduce their refining utilization. We are also moving towards the spring (March, April) refinery turnarounds where refineries are taken off-line for maintenance and summer tuning. This should lead to a temporary softer crude market with somewhat weaker crude spot dynamics over the next couple of months which might weight bearishly on crude prices. I.e. crude prices could be more bearishly sensitive to ingredients like a stronger dollar and/or equity sell-offs.
In total and on balance, it still looks like the crude oil market is on a tightening path due to both voluntary and involuntary cuts by OPEC+. Set-backs in the oil price rally since late December is however clearly a risk with Nopec, US-China trade war, global growth concerns, weak refinery margins, US dollar strength and potential sell-offs in the S&P 500 as the main concerns.
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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