Analys
We can confidently say yet again that Saudi Arabia is the boss
Crude oil prices are pulling back this morning on China concerns. But Saudi Arabia is probably very happy with the overall situation. It has showed the oil market yet again who’s the boss and the world will also need more of its oil in the coming months. The global market is set to run a deficit of 1.7 m b/d in Q4-23 according to the latest IEA report if Russia and Saudi Arabia sticks to their current production. After now having put the market strait there is no reason for Saudi Arabia to let such a deep deficit and inventory draw actually play out. It would lead to much higher prices but Saudi would also receive a lot of political pain from the US, China, India, Europe. Why ruin the party with oil rallying above USD 100/b and drive up an ugly political debacle when oil at USD 85/b is such a beautiful place. Tapering of Saudi Arabia’s cuts in Q4-23 would be the natural thing to expect. But all through September at least there should be a very sharp and tight market.
Through most of the first half of this year all up until late June there was deep disagreement with respect to global oil demand. In its June oil market report (STEO), the US EIA projected an oil demand in Q4-23 of 101.8 m b/d while the IEA in its OMR report the same month projected a Q4-23 demand of 103.5 m b/d. Such magnitudes of diverging views with respect to global oil demand is very rare. Markets didn’t really know what to believe with deep fear of deteriorating economic outlook on top due to sky rocketing interest rates around the world and a sluggish Chinese economy. The actual level of global oil demand is usually something we only really know in hindsight. With lots of facts in hand the IEA now estimates that global demand was 103 m b/d in June and expects it to be 103.1 m b/d in Q4-23.
The world did indeed get a strong rebound in global oil demand as the world increasingly and fully emerged from Covid-19 restrictions. Increased flying, driving and strong demand for petrochemicals. But it took a little longer to materialize than expected and it was shrouded in fears over the direction of the global economy. Global demand at 103 m b/d is not about a vigorously growing global economy but mostly about normalization post Covid-19. The IEA now estimates that global demand this year will average 102.2 m b/d versus 99.9 m b/d in 2022 giving a rebound of 2.2 m b/d YoY. But if it hadn’t been for Covid-19 then global oil demand would probably have been averaging close to 106 m b/d this year and 106.5 m b/d in H2-23 if we assume the normal 1.3% oil demand growth since 2019 had taken place. Much of this normal oil demand growth is due to population growth which is relentlessly rising higher. There is thus still a potentially huge, pent up demand for oil which may have built up during the Covid-19 years. Whether that potential pent up demand will actually emerge or not remains to be seen. But for now we are at a solid 103 m b/d demand. This is what the market can see and believe in. But significant pent up demand may be lurking behind the curtains.
Saudi Arabia was probably very frustrated with financial oil markets as they sold oil heavily in H1-23 and drove prices lower even as Saudi Arabia could see in its physical oil books that demand was robust. Saudi Arabia made deep cuts to production from 10.5 m b/d in April and all the way down to almost 9.0 m b/d in July with same level also in August and September. This isn’t Saudi Arabia’s first rodeo and it has really showed the market yet again who’s the boss.
Global oil demand normally rises by 1.3 m b/d from H1 to H2. Production from OPEC+ has however declined by 1.6 m b/d from April to August. And market is now very tight. If Saudi Arabia and Russia sticks to their current production levels throughout H2-23 then the IEA projects a draw in global oil inventories of 1.7 m b/d. That is a big, big draw which would drive oil prices yet higher. The price of sour crude (Dubai) which normally trades at at discount to sweet crudes is now instead trading at a premium. That is how tight the sour crude market has gotten.
But Saudi Arabia now has plenty of spare capacity at hand and it can easily lift production by 1.5 m b/d again back up to 10.5 m b/d. While they may chose to keep production at around 9.0 m b/d for a little while longer they have no good reason to drive the oil price up to USD 100-110/b. That will only give them large political problems with their main consumers. For sure neither the US nor China or India will be very happy.
Saudi Arabia should be fully content for the moment. It has shown the market yet again who’s the boss. It has driven the oil price back up to a very satisfying level of USD 85/b (ish). The world needs more of its oil and Saudi has spare capacity to provide it. Could it be better? Hardly.
US oil inventories with and without SPR. We still haven’t seen a decline in US crude and product stocks excluding SPR. But that will be the proof of the pudding. A running global deficit of 1.7 m b/d will eventually show up in declining US crude and product stocks.
Main oil product stocks in the US are lower this year than last year. At least a little. Refining margins are very strong as a result of reviving global demand for gasoline and jet fuel. When refining margins are strong then refineries make a lot of money and then they buy a lot of crude oil to make more.
Refining margins ticked lower following crazy levels in 2022 but have now shot back up again as demand for gasoline and jet fuel has revived post Covid-19.
Significant cuts from Saudi Arabia and some cuts by Russia has made total OPEC+ production fall like a rock (blue line). But that also means there is more spare capacity at hand.
The sharp decline in production from OPEC+ has led to a rebound in the time spreads for both Brent crude and Dubai crude. The tightening by OPEC+ is so large that Dubai sour crude now trades at a premium to Brent crude which is highly unusual (lilac graph).
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.
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Oil product price pain is set to rise as the Strait of Hormuz stays closed into summer
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