From Global Risk Management
The Oil Market Quarterly Outlook Oct'18
In the Quarterly Oil Market Outlook we look at fundamental, geopolitical and financial influence on oil price development over the coming quarter and we find that most parametres point to bullish outlook.
Main potential oil market driver is the U.S. re-imposing of sanctions against Iran from 4 November which have already, even though not yet implemented, caused heavy oil price fluctuations over the last couple of months. Iran is one of the largest oil producers in the world and taking the country's oil exports off the market would call for increased supply by other oil producers if oil prices should remain unaffected. Hence, market focus is on news and numbers from oil producers to grasp if they will be able to offset the missing Iranian barrels.
A side-effect of recent elevated oil prices could be limited economic growth especially in the emerging markets, but this remains to be seen, according to our analyses, as there is likely a time lag.
Conclusion is that supply/demand balance could shift during this quarter and risk of oil price fluctuations is imminent and a general uptrend seems in place, at least with the current outlook.
Stable U.S. crude oil production with bottlenecks. Decreasing production in Venezuela and Iran. Large world demand on oil while China and India lower import from Iran.
U.S. exports and production
U.S. production has been rapidly increasing mainly driven by investments in the Permian Basin. However, the pipeline capacity is starting to become a scarce resource which prevents further investments in drilling from being profitable. The effect on the U.S. production is that it on a weekly basis has been fluctuating between 10.9 mbpd and the record high of 11 mbpd. This suggests that the U.S. production has reached a relatively stable level. As new pipeline projects are not expected to be online until end-2019 or during 2020 the U.S. production is not expected to increase remarkably during Q4.
Venezuela’s economy continues to deteriorate and oil production continues the decrease. During Q3 the production has decreased from 1450 kbpd to 1380 kbpd. This trend is expected to continue as there currently is not a great appetite for foreign investors to invest in the country due to fears of nationalisation of assets from investments.
Iran starting to produce less
Turning to the likely decisive fundamental dynamic in Q4 – the Iranian production and exports. As the U.S. has pledged to re-impose sanctions on imports of Iranian crude oil, the market is increasingly concerned about the Iranian production being jeopardised, and for good reason. Last time such sanctions were imposed on Iran between 2012 and 2015 the country saw its oil production drop by about 1 mbpd – more than a quarter of the total production. The decisive factor is, however, how much crude the country exports. Already the production is observed to be decreasing, having dropped by more than 300 kbpd since Q1. Furthermore, the latest export figures show a remarkable contraction (see below graph).
At the moment world oil demand is more than 100 mbpd. World demand has increased during the last 2-3 years and during Q3 2018 supply seems to be unable to keep up with the demand growth.
It is the developing countries who are driving demand and especially India and China are big players on the scene. Furthermore, these two are decisive players in terms of how much crude oil Iran is going to export after the sanctions kick in at in November. China is historically the largest importer of Iranian crude followed by India and then Europe.
Chinese imports of Iranian crude were during August the highest recorded this year. This does not come as a surprise as China is knee-deep in a trade war with the U.S. (for more about this see the geopolitics section). Therefore, Chinese imports of Iranian oil were initially not expected to decrease remarkably. However, latest numbers (see below graph) show that Chinese imports of Iranian crude dropped to the second-lowest this year. These figures came along with news about a large Chinese energy and chemical company halving inputs from Iran likely as they were put under heavy pressure from U.S. officials.
Imports of crude into India has been dropping through an unhealthy cocktail. Higher oil prices in combination with a weaker Rupee has allegedly dampened Indian appetite for oil as can be observed from below graph.
Another important development in the Indian demand is that the imports of Iranian crude are decreasing on average. They reached a high of 736 kbpd in June and during August and September the average was 485 kbpd, suggesting that the 2nd largest importer of Iranian crude oil could be looking for other alternatives. According to sources some of the largest refiners in India have not booked any Iranian crude for November and forward as the sanctions kick in. If true, another 400-500 kbpd are jeopardised and would have to be found elsewhere.
Other key importers
Europe consumes about 500 kbpd of Iranian crude and allegedly some of these imports are already cut. Recently more countries have followed including Japan and South Korea. As Japan is looking to halt imports from Iran an additional 150 kbpd would have to be found elsewhere. South Korea allegedly already halted imports which peaked earlier this year at just below 300 kbpd.
The U.S. sanctions on Iranian crude oil could shift supply and demand balance during Q4. The key dynamic in this conundrum is how many barrels less the world will consume of Iranian crude, and is the rest of OPEC mainly Saudi Arabia and non-OPEC member Russia going to and able to offset it?
Below is a table consisting of key takeaways about larger players in the market
At first India wasn’t really expected to cut demand of Iranian oil but this seems to be changing. One reason is that imports already have plummeted (see above graph of Indian imports) another indicator is that India’s oil ministry already in June told refiners to prepare for a “drastic reduction or zero” imports from Iran from November. Lastly news was out that top Indian refiners allegedly would stop importing Iranian crude and even more surprising are the latest import numbers from China.
The graph below compares three bars: the first bar shows the crude oil exports from Iran. The second bar shows, the crude oil spare export capacity by OPEC and non-OPEC oil producers. This bar consists of spare export capacity by Russia, Saudi Arabia and a potential bulk capacity from the rest of OPEC (2500 kbpd). The 2500 kbpd is the sum of the largest ever recorded monthly exports from each OPEC country. This does not include Libya, Nigeria and Venezuela as production in these countries is too low to justify former maximum exports still being possible. Furthermore, this capacity is assessed rather uncertain for two reasons – the exports from the rest of OPEC has been volatile (unstable) and the production cut is still in effect (although not as severe as initially). Third bar is the spare export capacity minus the Iranian exports. Thus, the graph shows us that without Iranian crude oil exports, there could theoretically still be a surplus on the global market of 1675 kbpd crude oil.
However, the 2500 kbpd of spare capacity from other OPEC countries are under pressure. As stated, this number derives from the maximum export of crude oil ever recorded. In these months production was high as well. At the moment production seems under pressure meaning that if these countries were to utilize this alleged capacity their storage would quickly deplete. Ultimately this would conclude in exports aligning with production at a lower level. Thereby the potential bulk of 2500 kbpd should be regarded as the absolute best case spare export capacity.
The concluding remark is that the market is starting to seem squeezed, but a lot of countries including India are allegedly going to decrease imports from Iran further during October with the joker being China. Further cuts in imports from Iran are expected to squeeze the market, therefore fundamentals are assessed bullish.
"We set crude fundamentals to bullish"
The U.S. - Chinese trade war and emerging markets as the primary financial drivers of the world oil demand.
The trade war
During Q3 the trade war between China and the U.S. escalated further. The two countries are imposing different taxes/tariffs on imports. Market fears are that global economic growth will slow down and thereby spill over to oil demand weighing on oil prices. The important thing to be aware of on this topic is that to such political actions there are typically tied a lag. Meaning that from the day a tariff takes effect it usually takes time before ripples reach various markets and even longer before growth is affected. That being said, this is bearish for world trade, but the magnitude of it is difficult to assess with regards to its impact on the oil demand/oil market.
Looking at the financial factors:
The most important measure is the GDP growth. Latest data from Q2 shows that China up until Q3 was not really affected growth-wise. However, looking at imports/exports, exports are below average which likely could be an effect of U.S. tariffs as the U.S. is a big export market for China. The retail sales are typically a good initial indication of where an economy is headed. As this measure consequently has dropped throughout the year this is a bearish indication. Furthermore, the manufacturing PMI seems affected as both the public Chinese survey and the Caixin survey show declines. Both are, however, still above the 50-threshold indicating manufacturing expansion, albeit at a slower pace. As these financials are looking bearish all eyes will be on the Q3 GDP growth figures released end of October. As financials seem rather bearish the GDP growth figures could turn out to be as well.
In the U.S., GDP growth does not seem to be affected by the trade war as the latest figures show a massive 4.2% growth since last quarter (QoQ). Looking at the GDP growth comparing a quarter to the same quarter last year (YoY), growth has been steadily increasing as well. The retail sales look bearish, much like in China, which could be an effect of the trade war, however, the PMI tells another story which is a rather bullish one as this month showed the highest this year.
The, U.S. central bank - Fed, increased the interest rate again and one more could follow next quarter. With the U.S. economy expanding and the unemployment rate low it does seem like a good time for increasing the interest rate. The pitfall is though that the U.S. is heavily indebted suggesting that raising the interest rate will increase the expenses of this debt. Furthermore, higher interest rates in the longer term have the potential of decreasing growth by decreasing investments and the dollar is usually affected bullishly by an increasing interest rate. A stronger dollar is known for decreasing oil prices. Despite the rising rates and a relatively strong dollar the price of oil does not seem to be affected by these dynamics emphasising the current strength of the bulls in the oil market.
Generally speaking the current state of the U.S. economy does not seem to affect the global oil market at the moment as it is mainly non-OECD countries which are driving the world’s increasing demand.
As mentioned above, the emerging markets (most non-OECD countries) are the primary drivers of world oil demand, meaning that their domestic currencies’ strength against the dollar is important – because:
When a country imports oil, it would naturally have to pay for it. As oil is usually traded in USD, the importer would have to pay in USD. In order to be able to pay in USD the importer would have to first exchange domestic currency for USD. If the exchange rate between USD and the domestic currency as an example drops from 1:5 to 1:10, the importer would now have to pay twice as much domestic currency for the USD in order to pay for the oil. As a consequence, oil will effectively be more expensive.
During Q3 many emerging markets saw their currencies drop remarkably meaning oil became more expensive. Additionally, oil prices have been increasing during Q3 which further makes it costlier to import oil. The market concern is that the oil demand is ultimately going to decrease. Total Indian oil demand has been decreasing since June this year likely as an effect of the currency and the oil price. But in the longer term this dynamic is probably just going to be a bump on the way for most emerging markets as growth is still positive and firm.
The trade war is a hot potato and has been for most of the year. Q3 was no different as the trade war escalated. Fears in the market are that this will hamper global growth and spill over to the oil market. So far there is no sign of a slowing global growth in terms of GDP, but looking internally into the U.S. and China, retail figures allegedly point to some goods becoming more expensive. However, another potential danger is luring which is the emerging markets’ exchange rates to the USD. Many of these have weakened - making oil more expensive to buyers in emerging markets. Global demand for oil does, however, not currently seem to be remarkably affected by the exchange rates and prices, therefore financials are set to neutral.
"We set financials to neutral"
U.S. reimposing sanctions against Iran, continued crisis in Venezuela and tensions in the Middle East.
The sanctions against Iran have been quite the conundrum since they were announced by the U.S. president earlier this year. Initially the market reacted bullish, but during Q3 market consensus drew closer to OPEC+ being able to offset the missing barrels from Iran as the other parties of the agreement to lift sanctions back in 2015 continued the nuclear deal. However, as the sanctions are closing in more countries are starting to reduce imports, including India and China, the two largest importers of Iranian crude. Countries trading oil with Iran do have the possibility of applying for waivers, but none were given to South Korea and Japan which is why waivers for India are less likely.
The trade war between the U.S. and China escalated heavily during Q3. Latest development on the matter is that the U.S. in end September imposed the largest round of tariffs of $200 billion worth of Chinese imports. The tariffs start at 10% and are going to increase to 25% by year end. China responded rather rapidly with $60 billion in tariffs.
With regards to the oil market a war of this magnitude could harm growth and thereby lower oil demand. However, at the moment it doesn’t seem to harm the global economy but usually such macroeconomic shocks take time to affect other markets – a so-called lag. If the trade war is actually going to affect the oil market is neither certain nor known, but very possible in the longer term (see financials for a status of world economic status).
The crisis in Venezuela is not easing, the economy is deteriorating, and oil production is further decreasing - getting back on its feet by itself seems difficult at the moment.
The Venezuelan president visited China during Q3 and returned with the message that China had agreed to invest $5 billion in Venezuela. Such a solution would allegedly be beneficial for both countries as China potentially could be looking to decrease imports of U.S. crude. Venezuela could potentially compensate some barrels if such an investment landed in the country’s deteriorating oil infrastructure. The issue is, however, that Venezuela has already taken on a lot of debt to China during the last decade and has only been able to pay it back by shipping crude. Question is therefore if China really acknowledges this as an opportunity. So far there has been no official comments from China.
Middle east tensions
The conflict in Libya is still very serious and the Red Cross calls the situation desperate. Despite that, the chairman of the state-run National Oil Corporation said that production in September went as high as 1.28 mbpd which would be the highest since 2013. However, production is likely still fragile and until now production has fluctuated between 0.65 mbpd and 1 mbpd this year.
Attack in Iran
On 22 September the Iranian Ahvaz area was attacked by alleged terrorists at a military parade. The area produces nearly 1 mbpd and holds 23% of Iran’s oil reserves. Market analysts claim that this attack led to a sharp spike in prices and that this is an indication of elevated geopolitical risk in the oil market as such attacks could easily happen again and that oil infrastructure could be targeted.
Iran threatening to close the Strait of Hormuz
Iran has been threatening to close the Strait of Hormuz with military force as a reply to the U.S. re-imposing of sanctions against the country from November. The strait is a key vein of oil supply from the Middle East to the rest of the world as about 30% of the world's sea-born exports flow through. A military action from Iran is, however, unlikely. The point of Iran making such threats is likely not to scare the U.S. away from actually introducing the sanctions, but rather as a means to hurt crude exports from other countries. The thing is that the oil market reacts to the threat alone and in general it increases the overall geopolitical risk premium in the market.
During Q3 the sanctions against Iran have increased the global geopolitical risk premium and most countries are complying in larger or smaller degree to the sanctions, some more rapidly than others. At the moment it seems likely compliance is going to be fairly high.
Allegedly, the Libyan production stepped up remarkably during Q3, but even so it is too early to count on increased production from there as the situation is still fragile.
The bearish side of the geopolitics is the trade war between China and the U.S. The war has been escalating during Q3 and it does not seem to turn around during Q4. Fears are that the trade war will slow down global growth (for more on the matter see financials), but it is likely too soon to be certain of that. Therefore, geopolitics are assessed slightly bullish.
"We set geopolitics to slightly bullish"
Oil price forecast (average)
Please note that the forecast is the AVERAGE price per quarter. Thus, prices during the quarter will likely be both higher and lower.
How is the report structured?
The report is divided into three parts – each part elaborates on three main topics which are influencing the oil prices:
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