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Geopolitics on the back burner despite Middle Eastern troubles

Rosier-than-expected fundamentals are easing oil prices – for now

With forecast output growth of 5 million barrels a day (b/d), Iraq was to be a cornerstone of global oil supply security over the next two decades, accounting for 45% of the world’s extra crude by 2035. Yet about a third of the country is now in the hands of Islamic State (IS), the brutal Sunni Jihadists who want to create a caliphate stretching across northern and western Iraq and eastern Syria. 

IS is not yet a threat to the Shia-dominated south of Iraq, home to the mega-oilfields that account for the bulk of Iraq’s output. But political chaos in Baghdad and the risk of more sectarian strife, coupled with Iraq’s corruption and chronic bureaucratic problems, mean no one should pin their hopes on a doubling or tripling of output from the country along the timetable predicted by the International Energy Agency (IEA).

The oil production picture is grim elsewhere, too. Syrian oil -- output was about 400,000 b/d before the revolution in 2011 -- is now largely in the hands of IS. Luay al-Khatteeb, a visiting fellow at the Brookings Institution in Doha, says the group’s oil smuggling earns it about $2m a day, enough to sustain its war effort.

The sanctions-hit Iranian energy sector pumped 2.76m b/d in July, or about 1m beneath the level for the same month in 2011, before Western powers imposed their embargo. Libya’s production is climbing again and is at 550,000 b/d now, but still remains well beneath the 1.6m of the Qadhafi-era. Militia violence and a political vacuum threatens even this modest recovery. Output from Nigeria, where the government seems to have lost control of big parts of the country, continues its slow decline. 

In Russia, meanwhile, Western sanctions on the technology needed for enhanced oil recovery and exploitation of undeveloped tight-oil reserves will surely stall the country’s long-term goal of keeping output above 10m b/d. Rosneft and other big Russian firms now face problems funding future upstream spending projects, too.

A few years ago, any one of these problems could, individually, have sent oil prices sharply higher. When Libya’s output collapsed in 2011, only a coordinated stock release from the IEA prevented a spike in prices. In jumpier market times, even war between Israel and Hamas -- neither of which produces a drop of oil -- pushed oil higher. 

This time there has been barely a peep from the market. Despite all the violence in and around oil-producing countries, especially in the Middle East, Brent prices keep falling. Even the renewal of US military engagement in Iraq, when its air force began supporting Kurdish forces to reclaim some territory in the north, has scarcely moved the price. Since a high above $112 a barrel after IS’ capture of Mosul in June, front-month Brent has dropped steadily. On 20 August, it was trading just above $102/b.

What has changed? 

The departure of some speculative money from the oil market may be one difference. Some analysts suggest that as big banks have unwound some of their positions, the automatic buying sprees that followed gloomy oil news have become less powerful. This is difficult to prove. A better explanation lies in the fundamentals. Lower forecast global GDP growth has filtered into a grimmer-than-expected outlook for consumption from the IEA. Demand will rise by 1m b/d this year, the agency said in an August report. That was another trimming of the outlook from its monthly report in July — but a whopping 400,000 b/d beneath its forecasts from earlier in the year. 

Despite the problems afflicting producers in the Middle East and North Africa, meanwhile, the supply picture is also rosier. A rise in Saudi Arabia’s output during July, to 10.01m b/d, helped offset some of the losses elsewhere in Opec. The group’s total output rose to 30.44m b/d, or about 450,000 b/d above what the IEA believes will be the average call on its crude this year. Some Opec oil is even having trouble finding a place in the market. Libya’s NOC, for example, is now thought to be considering offering discounts to entice traders to lift its oil, according to Petroleum Policy Intelligence, a consultancy. 

That reflects how refiners that once counted on Libya’s high-quality supply have adapted to cope with its unreliable exports. But it is also a product of a glut of supply in the Atlantic basin, according to the IEA. “Surprisingly steep demand contraction” – second quarter 2014 consumption in Europe was 300,000 b/d lower, year-on-year -- has come up against “relentless North American supply growth”. Indeed, despite a seasonal dip in output during July, non-Opec output was 1.2m b/d higher than in the same month last year. 

It is this supply growth from the US that is doing most to calm markets. Despite the continued decline of Alaska, rising tight oil production pushed US output in July to 8.4m b/d, about 1m b/d more than last year -- equivalent to adding the output of Colombia to global supply in just a year, noted the IEA. Bakken production on its own is expected to rise to 1.2m b/d by the second quarter of 2015.  

Rising global stock levels also show the impact of this new oil supply. OECD commercial inventories added 88 million barrels in the second quarter, the largest quarterly build since 2006, and equivalent to 970,000 b/d, said the IEA. Industry stocks built for their sixth consecutive month.

These fundamentals leave grounds to expect oil prices to keep easing in the short term, despite the turmoil in many oil-producing countries. But consumers should not be complacent. The forward curve for Brent, now in mild contango, could get steeper. At some point, US supply growth will ease and production will reach a plateau. Geopolitics may have lost its force on the market for now, but the deep and lingering problems facing Iraq, Iran, Nigeria, Russia and Libya show no signs of swift resolution — and every sign of turning into chronic illnesses for some of the world’s biggest oil producers. 

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