Short-Term Crude Price Outlook
On November 4th, 2018, Iran will again be subject to sanctions imposed by the United States, placing both the Islamic Republic and the global oil market as a whole under considerable stress. Because the pursuit and sale of oil is so closely tied to geopolitics, more so than any other industry is, stakeholders and analysts have expressed a wide variety of opinions derived from differing perspectives on certain variables, including Venezuela's political turmoil, OPEC's production limits and President Trump's erraticism, and where said variables will push prices over the next few years, resulting in greater short-term volatility as shown by the rising OVX. Yet even with so much information available at one’s fingertips, the question still remains: how will prices respond to sanctions and what are the likely consequences for oil producing nations?
Over the course of the last 12 months, crude oil prices have increased roughly 50% and the idea of a return to $100/barrel is no longer far-fetched. Equally surprising for energy traders is that one of the drivers behind the price increase has been a prominent world leader's usage of social media as a medium to vilify his perceived enemies and engage in self-congratulatory celebration. Said leader has recently reimposed US sanctions on Iran, a country that, when unencumbered, can produce over 3% of the world's oil supply, or 2.5mm barrels per day. Additionally, questions over Venezuela's output amidst political and economic quandary have done little to soothe the market.
Addressing these concerns during the three day Oil & Money conference in London earlier this month, the world's most prominent independent oil traders expressed deep divisions over the crude price outlook, setting up a major battleground for the industry in 2019. Jeremy Weir, Chief Executive of Trafigura, and Alex Beard, head of energy at Glencore, expressed confidence in higher prices for the foreseeable future with both citing the Iranian sanctions as the primary driving force, although underestimated strength of recent economic growth has also played a role. A conflicting opinion is shared by Ian Taylor, Chairman of Vitol - the world's largest independent oil trader, and Torbjorn Tornqvist, CEO of Gunvor, as they predict prices falling due to lower demand and believe fears over Saudi Arabia's ability to compensate for the deficit are overstated. As a result, the latter pair consider a $65-75/barrel price range to be more likely.
Despite the windfall of profit that higher prices bring their State-operated oil firms, both Saudi Arabia and Russia have increased crude production to fill the gap that is to be left by Iran in an attempt to maintain a certain degree of market stability. The former alone has bumped production up to 10.7 million barrels/day - equal to its highest level on record, and a hike of roughly 700,000 barrels/day over the last few months. However, there are a few factors stopping them from fully compensating for Iran’s drastically reduced output. Most pressing is the lack of infrastructure preventing both further increases in production and transportation to market, thus rendering a portion of tapped oil effectively useless. Across the Atlantic, a similar predicament has presented itself as the number of American crude rigs has dropped and concerns mount that pipeline restraints will limit growth in the resurgent Permian Basin. Moreover, a solid majority of American refineries are not equipped to process Shale oil, which is light and sweet in contrast to the heavier oil typically drilled in North America. Further downstream, the US faces limitations to its ambitions of becoming an even larger crude exporter due to a lack of storage in some locations and, more critically, the fact that most Gulf Coast terminals were built as import, rather than export, facilities and due to their limited depth cannot currently accommodate the largest tankers. The International Energy Agency, however, predicts these export limitations will be eased over time as infrastructure investments raise capacity from the current 1.9 millions barrels per day to nearly 5 million by 2023, slightly allaying fears that higher prices will be here to stay.
What is ultimately most interesting to consider is the impact of possible scenarios on each of the major oil producing nations, all of whom have build a considerable portion of their respective economies around the energy sector. Most prominent is the United States, the world’s largest economy, and President Donald Trump, the aforementioned leader who recently lambasted OPEC via Twitter in an effort to prod them to increase production as the Iranian sanctions take effect. With gasoline reaching $3/gal in many places across the country while incumbent Republicans fight to maintain control of the House and Senate, Mr. Trump is feeling pressure to aggressively cater to the working class voters who are most affected by inflation with respect to normal goods. However, unless he is willing to provide limited waivers to buyers of Iranian oil, as the Obama Administration did leading up to the 2015 nuclear deal, he risks further price increases to go along with rising Federal interest rates as midterm elections near. Russia and Venezuela would undoubtedly benefit most from higher prices, with the former's State-controlled oil giant, Rosneft, being a major provider to Europe and China while the latter is in need of an influx of cash as its creditors seek to lay claim to Citgo, one of the nation's few valuable assets, as it reels from hyperinflation, food and medicine shortages, and a population exodus. Of all countries involved, none is in a more interesting predicament than Saudi Arabia - home to one-fifth of the world’s proven oil reserves. On one hand, higher prices keep revenue at a level that will maximize the value of Saudi Aramco, the State-run oil titan and most profitable company in the world, as it prepares for a 2019 IPO - the largest in history - while also boosting the sovereign wealth fund that backs Crown Prince Mohammad bin Salman’s Vision 2030 plan that aims to reduce the country's economic dependence on the sale of oil, which accounts for 30-40% of its GDP. On the other hand, low prices allow Saudi Arabia to keep and grow its market share as it is able to produce oil at a lower cost than any of its competitors - slimming or eliminating profit margins for rivals such as Iran and Qatar. The striking twist to the Saudi situation is the ongoing development of the story behind journalist Jamal Khashoggi’s disappearance. After finally admitting that Mr. Khashoggi is dead, albeit under dubious circumstances, the world awaits a response from the West’s powers that be. In the event that Mr. Trump and company take the Saudis at their word, Iran will continue to be the center of attention for all with an interest or stake in the market. But if the Gulf State were to be punished for its actions, the list of possible consequences is seemingly endless. Because oil-related sanctions would be such a huge blow to the Saudi economy, this would provide China, who has historically had few, if any, reservations in silencing critics of its regime, with an opportunity to expand its relationship with Mohammad bin Salman in order to feed its growing thirst for energy. It would also send Western oil and gas prices skyrocketing as more than a tenth of the world's current supply would become inaccessible to the majority of developed nations, placing unprecedented stress upon those operating in the Permian Basin and North Sea to produce impossibly large volumes of West Texas Intermediate and Brent Crude, respectively.
What is beyond question is that political instability and erratic decision making by world leaders will continue to promote market volatility and the cycle of moving from problem to problem will continue indefinitely. The world will most likely get the lower prices that the United States and its leadership seek, but not because Mr. Trump can tweet-demand more oil from OPEC. Saudi Arabia will almost surely go effectively unpunished as further price hikes would add additional pressure to incumbent politicians attempting to fight off the populist tide that stretches from Seattle to Warsaw. Additionally, moderately high prices often take care of themselves, simply because they reduce demand quickly, ensuring that supply side restraints will eventually return in a pendulum-like cycle that will continue swinging for the foreseeable future.