Oil prices have been in the doldrums since the collapse from record highs of over US$110 /barrel in June 2014, broadly trading sideways in a US$ 40-60 range until late last year, when prices broke out, and passed US$70 for the first time in over 3 years this week.
This price rise has been driven by a combination of factors: production cuts by OPEC and some non-OPEC countries, demand growth, and uncertainty over the Iran nuclear deal – although with yesterday’s announcement, markets are now absorbing what the US withdrawal will mean.
According to James Williams, energy economist at WTRG Economics, the primary reason for the oil price recovery has been agreement by both OPEC and non-OPEC producing countries to limit production at a time of exceptionally high stocks. Under the deal, which was implemented at the start of 2017 and is due to run until the end of this year, OPEC and other major oil producers, including Russia, agreed to cut crude production by roughly 1.8 million barrels a day from late 2016 levels in an effort to eliminate a longstanding oversupply position. Saudi Arabia and Russia are apparently in discussions over a “very long-term” pact, possibly over 10-20 years, to co-ordinate on production levels.
In addition to agreed production cuts, supply has been affected by unintentional reductions in Venezuela and Mexico which have lost a combined 890,000 barrel/day versus the October 2016 baseline. Chronic mismanagement has pushed down Venezuelan crude production by 580,000 barrel/day over the last year, and is set to fall further according to the International Energy Agency (“IEA”). Financial difficulties, have led to missed payments to oil services companies, and under-investment has led to equipment failures which have been exacerbated by a shortage of key staff and wider labour unrest.
These reductions in production mean there is now talk of possible shortages, particularly in the event of one-off disruptions:
“The global market has tightened considerably in recent months…. [The Organisation of the Petroleum Exporting Countries is] very close to achieving its originally stated aim of bringing OECD stocks back to parity with their five-year average. What we are seeing happening, and will occur much more frequently going forward, is that one-off [supply issues or threats] will start to have a more pronounced impact upon prices,”
– Matthew Parry, head of long-term research at research consultancy Energy Aspects
At the same time, demand has been growing in line with higher economic growth. The IEA forecasts global energy demand of 99.3 million barrels a day this year, up from 97.8 million in 2017, however, the IEA noted that any trade dispute between the US and China would be negative for demand.
“Globally, we expect oil demand to grow by 1.5 mb/d in 2018. However, there is an element of risk to this outlook from the current tension on trade tariffs between China and the US,”
The OECD economic outlook remains supportive, with strong growth in most countries, particularly “advanced economies” – the outlook, published in March, sees world growth at 3.9% in both 2018 and 2019, similar to the assumptions underpinning the IEA demand forecast.
Prospect of renewed sanctions on Iran
Yesterday oil prices swung around as the markets tried to get to grips with what Donald Trump might do in relation to the Iranian nuclear deal, falling significantly ahead of the announcement that the US would be pulling out of the deal, and subsequently recovering, with the announcement that sanctions on Iran would be re-instated.
Iran’s oil production has bounced back to nearly 4 million barrels / day since sanctions were eased. Re-imposing them could reduce Iranian oil exports – analysts surveyed by Bloomberg last month said the production impact could range between zero and 800,000 barrels / day, which would lead to further price increases, with Saudi Arabia seen as unlikely to step up production unless prices reach US$80 / barrel. Russia and China, could still provide markets for Iranian oil – Russia having coped with US-imposed sanctions for a number of years.
Any sanctions would also freeze any buyers of Iranian oil out of the US banking system making it difficult for companies to carry on doing business with Iran.
The White House has significant discretion over how quickly sanctions are re-imposed, and there is a 180-day grace period before buyers have to start reducing their volumes of Iranian crude after any decision to renew sanctions, so price impacts could be muted in the near term. Any increase in political tensions in the Middle East, particularly if Iran resumes its nuclear testing, could drive prices higher.
The global supply and demand balance had tightened significantly even before yesterday’s announcement. The prospect of renewed sanctions is likely to see prices track higher, absent any reversal of OPEC-driven production cuts.