Global Iran sanctions push up oil prices · 2018-10-04 · Iran sanctions push up oil prices 04...

Copyright BieResearch.com 2018 1

Global

Iran sanctions push up oil prices

04 October 2018

Ulrik Harald Bie, Independent Economist, [email protected]

www.bieresearch.com

• Production in Iran is tumbling as sanctions begin to bite

• OPEC only able to partly compensate for lower Iranian production

• US shale producers are facing short-term headwinds from pipeline bottlenecks

• Lower growth in global demand for oil as economic growth weakens

• Continued inventory withdrawal supports high oil prices

How high can oil prices go?

Crude oil prices have increased since mid-August and

took another step up after the latest gathering of

OPEC and Russia (OPEC+) ministers in late Septem-

ber. The current price on Brent crude oil of USD85

per barrel is the highest since November 2014 and up

more than 50% annually. That means energy will

continue to add to inflation in coming months.

The higher oil prices signal a quite remarkable suc-

cess for the OPEC+ agreement from November 2016

on limiting crude oil production. Regardless of Presi-

dent Trump’s tweets, there is little indication of any

major changes to OPEC official policy, although ad-

herence to the agreed targets could become less strin-

gent in the Gulf states with close US ties. President

Trump has threatened to make the countries pay

more for US military assistance if oil prices do not de-

cline.

Higher prices offer smoother conditions for oil pro-

ducing countries and have boosted the value of large

oil companies. This has reduced the economic risks

in the Gulf States, primarily Saudi Arabia. On the

other hand, oil consumers are now feeling a pinch,

which is particularly painful in the emerging-market

(EM) countries, where subsidies have been rolled

back and currency depreciations are already fueling

inflation.

In the US, gasoline prices are central to household

optimism. With midterm elections due in a month,

and import tariffs set to fuel goods inflation, Presi-

dent Trump is very much aware of the political impli-

cations of high oil prices. Shipping, airlines and

ground transportation are facing increasing costs –

just as labor cost is also moving up. This could lead to

more fuel surcharges and less favorable shipping op-

tions for internet commerce.

Oil markets are faced with strong tail- and head-

winds. On the one hand, global supply is not increas-

ing at previous speed with production declining in

Venezuela and Iran, while the US production spurt

has paused. Global inventories have been brought

down below the five-year average, and excess supply

has largely disappeared. On the other hand, there are

mounting downside risks to the outlook for global

crude oil demand due to trade wars and policy-tight-

ening.


US production has stalled

Production in the US has stalled in recent weeks at a

level around 11 million b/d after a period of strong

growth. The 2018 annual increase in US crude oil

production is set to be the highest in decades, further

cementing the pivotal role of shale producers in the

global oil market. Further increases are expected in

coming years, but headwinds are surprisingly strong

in the short run.

The increase in production, particularly in the Per-

mian Basin in Texas and New Mexico has vastly out-

performed the available infrastructure. Permian now

produces 3.5 million b/d, but the pipeline network

from the area can only handle about 3.1 million b/d.

Since spring, the capacity constraint has put a signif-

icant downward pressure on the prices received by

producers, as alternative means of transportation –

primarily rail and trucks – are much dearer. The pro-

duction surge has also led to bottlenecks in the supply

chains, driving up prices on input materials for the

actual oil production: fuel, water, sand, and chemi-

cals used for fracking. Wage costs have also increased

as experienced workers are in short supply.

According to the US Energy Information Agency

(EIA), the price discount for Permian crude oil at the

well reached USD15-20 per barrel this summer. The

result is a slower increase in production, but also a

massive jump in the number of wells, which have

been drilled, but not activated for oil extraction.

Hence, when adequate infrastructure is in place, pro-

duction can be increased substantially and with short

notice. The current price level is above production

cost in all areas, even when taking the additional

transportation cost into account.

The EIA expect US crude oil production (not to con-

fuse with overall “liquids” production including

lighter products) to increase by 1.3 million b/d this

year and further by 0.8 million b/d in 2019. By com-

parison, OPEC projects that the strongest annual in-

creases in US production take place in the near-term,

expecting production to increase annually by 1.4 mil-

lion b/d in 2018-2020; the International Energy

Agency expects a production increase of 1.2 million

b/d in 2019. I expect US production to only increase

slowly in coming quarters as producers await im-

proved pipeline infrastructure and then pick up speed

later in 2019. That could limit the increase in US pro-

duction to 0.7 million b/d in 2019.

The US price standard (WTI) measures oil delivered

in Cushing, Oklahoma, and continues to trade at a

discount compared to world prices. This also reflects

transportation costs and bottlenecks in getting US oil


to the global market. US crude oil exports declined

substantially during the summer as the “war of tar-

iffs” between President Trump and China was heating

up, sending the Brent/WTI-spread up to USD9-10

d/b. Exports have picked up again in recent weeks,

but the spread remains elevated.

Brazil has disappointed

Other non-OPEC+ producers (Russia can currently

be counted as OPEC-like) have seen mixed fortunes

in 2018. Production in Brazil has thoroughly disap-

pointed, and instead of the expected increase of

around 0.15 million b/d, average production this year

is set to decrease slightly compared to 2017. Major in-

vestments in the offshore pre-sel oil fields should

begin to bear fruit in 2019, thus reverting to an up-

ward trend in Brazilian oil production. Canadian pro-

duction has tapped into the higher global prices and

continues to grow. At the current price level, the ex-

traction of crude oil from oil sands is profitable, and

the Canadian oil producers expect to increase pro-

duction by another 33% through 2035. That increase

depends on a continued expansion of the current

pipeline network, something that has met resistance

at both federal and provincial levels.

In total, I expect non-OPEC+ countries to add 1.3 mil-

lion b/d to global supply in 2019. That is lower than

the 1.7 million b/d added this year, but much more

diversified as the US only contributes half of the

growth compared to more than 80% this year.

Iran sanctions bite…

Oil exports from Iran have dropped since August as

the first round of US sanctions has hit shipping, in-

surance and payments. When the second round takes

effect in November, exports are set to plunge more

than in the previous sanction period (2012-2015) as

the Trump-administration has sent a strong signal

that it will provide few waivers. India, the second

largest export market for Iranian oil, has sharply cur-

tailed imports from Iran to obtain a US waiver for a

lower level of oil imports and could cut imports to

zero from November.

The EU has recently sought to establish a special pur-

pose vehicle to handle the financing, but corporations

with business in the US are likely to abstain from try-

ing to circumvent the sanctions. Two other large cus-

tomers, South Korea and Japan, are also set to stop

purchases.

China is the largest market for Iranian oil, which is a

bargaining chip in the ongoing trade war with the US.

So far, China has not levied tariffs on US crude oil,

but doing so, and maintaining purchases of Iranian


oil through specialized domestic financing vehicles,

would hit both the US oil industry and provide relief

for the Iranian government, which is almost entirely

dependent on oil revenues to finance public spend-

ing. It is unclear how the sanction/trade war scenario

between China and the US will play out.

If exports plunge to 0.8-1.0 million b/d (compared to

1.4 million b/d in 2014-15 and a peak of around 2 mil-

lion b/d), Iranian crude oil production could drop to

2.6 million b/d. That would take out as much as 1.2

million b/d of global supply, wildly exceeding expec-

tations from May. The miscalculation is an important

factor in the surging oil prices.

… but OPEC is responding

Production in Venezuela has decreased further to

only 1.2 million b/d – half of the production level in

2016 with no improvement in sight. Some of this is

also due to US sanctions but mostly reflects a collapse

in production capabilities as equipment and wells are

not maintained. That is important; Iran would be

able to fairly quickly reverse production decline

if/when sanctions are lifted, while Venezuela proba-

bly will have to go through regime change before any

new course can be set. Even then, massive invest-

ments in production facilities and infrastructure will

be needed.

At the meeting in June, OPEC decided to tweak the

agreement from 2016. Mainly due to the collapse in

Venezuelan production, the total production from the

OPEC-countries had declined to below the agreed

32.5 million b/d, so the organization agreed to in-

crease production to compensate for lower output in

some countries. However, already then a delicate bal-

ance had to be struck as all OPEC-decisions must be

unanimous. Facing sanctions, Iran did not want other

OPEC-countries to increase production to compen-

sate for the lower Iranian supply. If OPEC increases

production to match the Iranian decline, the entire

burden of the sanctions would fall on Iran with global

oil prices unaffected. Iran can now find some solace

in the higher oil prices and the negative impact on

global growth – and the American consumers.

Spare production capacity is primarily found in the

Gulf States (including Iraq) and Russia. Unsurpris-

ingly, this is also where production has been in-

creased in recent months. There is great uncertainty

about the amount of spare capacity. Saudi Arabia

claims to have a total capacity of around 12 million

b/d compared to production of 10.4 million b/d; the

additional 1.6 million b/d should be more than ade-

quate to compensate for production losses elsewhere.

However, many analysts dispute the Saudi claims and


see capacity as much lower. EIA estimate total OPEC

spare capacity to be around 1.6 million b/d. Russia is

still hit by sanctions, which limits the ability to obtain

foreign technology and financing. Iraq could increase

production substantially, but the security situation

and political fragmentation remain strong head-

winds.

I expect some production increase to take place, thus

partly compensating for the supply decline in Iran –

despite Iranian protests. This is likely done by stealth

rather than as a policy statement. The 2016-produc-

tion agreement should continue during 2019 as it has

served all participating countries well and compli-

ance has been quite good.

Nigeria and Libya are wildcards in total OPEC-pro-

duction and are not covered by the 2016-agreement,

as production in both countries is recovering from se-

curity-related issues. The situation remains fragile,

and major investments to boost production capacity

are not likely in the short term. Particularly Libya has

significant untapped reserves. Production averaged

1.6 million b/d in 2010 before the civil war compared

to a daily production of less than one million barrels

today.

OPEC has vowed to keep overall production close to

32.5 million b/d, which would imply an increase in

production of 0.2 million b/d in 2019 compared to

2018. That is a very ambitious target. With Iranian

production set to decrease by around 1 million b/d

and Venezuela another 0.3 million b/d, other OPEC-

countries and Russia would have to increase produc-

tion by 1.5 million b/d. It is doubtful that amount of

excess production capacity exists – and the political

fallout with Iran and allies is likely to restrain the

other OPEC-producers. I have penciled in a decline of

0.3 million b/d in overall 2019-crude oil production

in OPEC+.

Demand growth to weaken

From mid-2017 to mid-2018, a surprisingly strong

growth in oil demand helped bring down global in-

ventories. The period saw strong increases in busi-

ness confidence and a surge in economic growth and

trade, prompting international institutions to fore-

cast a synchronized recovery for 2019. That assess-

ment is now in tatters and forecasts for 2019 in the

process of being marked down.

It is too easy just to blame President Trump’s trade

wars. While a piece of the puzzle, the continued tight-

ening of US monetary policy is a more important fac-

tor, causing EM-countries to tighten domestic policy


to counter the inflationary impact from deflating cur-

rencies. Domestic policy errors are adding to the eco-

nomic woes in a number of countries with Turkey,

Brazil and Argentina facing recessions. China is eas-

ing economic policy but is still likely to suffer a period

of slower growth, particularly exports.

In the euro area, GDP-growth is moderating with

headwinds forming in Spain and France, where con-

sumers have become more cautious. Italy could see

some short-term boost to household consumption

from the new budget plan, but the political uncer-

tainty is weighing on business investments. Germany

is best positioned to maintain strong domestic

growth, but the export sector is feeling the less benign

global framework; US auto tariffs remain an im-

portant threat. Auto sales have been a strong driver

of European growth (although sales are down 20% on

the year in the UK), with car registrations in the euro

area hitting an all-time high in August. Strong sales

should continue, but the growth rate is due for mod-

eration. I expect GDP-growth of 1.6% in 2019.

The US continues to enjoy the benefits of tax cuts and

record-high optimism. Underlying growth should re-

main strong, although the trade war with China is set

to mess up quarterly measurements of net exports

and inventories. Wage growth is inching up, but with

inflation on the rise as well, consumer will have to dip

into savings to maintain even a moderate growth in

consumption. Higher energy prices have added

USD100 billion to the household energy bill since

2016. Despite the record-high sales of SUVs and

trucks, gasoline consumption has been stagnant with

overall oil demand spurred by non-gasoline oil prod-

ucts. I expect the US economy to growth by 2.8-3.0%

this year and 2.5-2.7% in 2019, when tariffs should

push down consumption growth. Investments in en-

ergy extraction and infrastructure should be an im-

portant driver of economic growth.

With the headwinds to global economic activity

strengthening in 2019, I expect GDP-growth closer to

3.2% compared to the IMF-forecast of 3.9%. IMF has

already announced that the growth projections will

be downgraded in the next update on 9 October.

Hence, the increase in global crude oil demand

should decline from approx 1.5 million b/d this year

to 1.1 million b/d next year.

Some more inventory reduction ahead

With limited growth in US production in the short

term and a large decline in Venezuela and Iran, only

partly countered by increased production in other


OPEC+ countries, I expect global crude oil supply to

increase by a meager 1 million b/d in 2019. By com-

parison, the US EIA expect twice as much additional

supply, so my forecast is certainly low. However, I am

also much more bearish on global demand growth

with a forecast of 1.1 million b/d in additional de-

mand.

The drawdown of global reserves is thus likely to con-

tinue in 2019. There is an overweight of negative

risks to the supply outlook and an overweight of

positive risks to the demand outlook, creating up-

side risks to future inventory reduction. That creates

an environment, where oil prices could increase fur-

ther in the short run.

However, oil prices have moved out of the “Goldilock”

range, where they are high enough to support oil pro-

ducers, but low enough to prevent too much pain for

consumers. Now the pain is dominating, and higher

prices are likely to curtail global economic growth –

and accelerate the transition away from crude oil de-

pendency. Short-term uncertainty about the supply

situation could keep the price of Brent crude some-

what above USD80 dollar per barrel, but demand

concerns should become a market issue, when an eco-

nomic slowdown becomes more visible. Brent oil

prices are likely to return to a range of USD75-80 per

barrel in coming months, but with risks skewed to the

upside.

Global Iran sanctions push up oil prices · 2018-10-04 · Iran sanctions push up oil prices 04...

Documents

Transcript of Global Iran sanctions push up oil prices · 2018-10-04 · Iran sanctions push up oil prices 04...