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Oil price puzzle as sanctions choke Iran exports

Which direction is the price of Brent crude heading following deployment of a US naval and B-52 bomber strike force to the Middle East? The answer is complex

Amid rising tension between Washington and Tehran, markets must also add into the mix the loss of barrels from sanctions-hobbled Iran and crisis-hit Venezuela, now also targeted by US sanctions.

Brent crude was up 33pc since the turn of the year before this month's downturn, following President Trump's decision in November last year to reimpose sanctions on the Islamic Republic, but this price rally had not seen any of the dramatic spikes of yesteryear, despite the scrapping of waivers in April.

Those waivers allowed eight countries, including India and China, to continue to import Iranian oil. By rescinding them, supply has tightened; and intelligence from tanker-tracking agencies indicates a dramatic choking off of Iranian crude that will be far more severe than the effect of sanctions imposed during the Obama era.

Evidence of market tightness is clear. For instance, demand for Opec oil exceeds supply with the original cartel producing about 30mn bl/d against demand for 30.7mn bl/d, according to Tamas Varga, an analyst at brokerage PVM Oil Associates in London.

It looks as if the 'common sense money' is on higher prices later this year, with a sharp jump in the number of long positions linked to Brent in the futures and options market, says Varga. Net speculative long positions (i.e. with shorts netted out of the calculation) were at 280mn bl on 5 March. By 7 May, that figure had jumped to 406mn bl.

But Germany's Commerzbank says there are good reasons why Brent is not higher—falling back in recent weeks from $75/bl in late April to under $70/bl. The bank's commodities analyst Carsten Fritch attributes this to concern about a further escalation of the Sino-American trade conflict that could potentially hit demand and an economic downturn in the US. That makes sense, when you consider the two protagonists, the US and China, are the largest oil-consuming countries, accounting for about one third of global oil demand and about half of the expected increase in global demand for oil.

Supply deficit to fall

Other factors are capping prices. First, US oil production and the expectation of higher Opec oil production in the second half of the year. 'The US Energy Information Administration expects daily production to increase by 1.5mn bl/d this year. This would be more than the expected increase in global oil demand, so the demand for Opec oil, and thus the supply deficit, is likely to fall again in the second half of the year,' says Fritsch.

Sentiment, he adds, is also affected by the expectation that Opec and the enlarged Opec+ that includes Russia will agree to raise production quotas at their June meeting in Vienna.

For now, there is plenty of Opec spare capacity. Saudi Arabia is able to increase oil production by up to 500,000bl/d in the short term without violating the current cuts agreement.

Saudi Arabia turned on the taps too sharply in autumn 2018, triggering a sharp drop in prices, so it is eager not to repeat the mistake. Warren Patterson head of commodities strategy at Netherlands-based ING, says current Saudi production is at around 9.8mn bl/d against 11.1mn bl/d last November, indicating 'embedded spare capacity'.

Nevertheless, there are worries about a looming supply crunch. An upswing in the civil war in Libya and tension between Iran and Iraq raise the spectre of more outages, on top of Iran and Venezuela. A fall-off in production from Iraq (albeit in a worst-case scenario) would be a body blow—the country is the fourth-largest producer in the world and second-largest in Opec behind Saudi Arabia.

For now, though, the big story is Iran. The Americans are shooting for zero Iranian exports. No one seems to think that is possible. But there are unmistakable signs that Iranian crude exports are falling fast.

April exports from Iran halved to 1.053mn bl year-on-year, according to Florian Thaler, CEO of energy analytics firm OilX. 'We think May could well end up being 550,000bl/d,' he says. Cargo tracking company Kpler says that figure is 'possible', although head of market analysis Alex Booth says China is unlikely to fall into line 'to a full degree'.

Loadings down, storage up

Kpler notes a significant increase in Iranian loadings through March and then a subsequent increase in discharges of Iranian barrels in April (in the run up to the scrapping of waivers). But this activity has fallen off considerably.

Booth reports a decrease in loadings through April and a corresponding increase in on-shore Iranian crude oil storage. 'Data so far in May—whilst still uncertain and subject to considerable revision—points to a marked drop in loadings and also a considerable decrease in imports in Turkey, India and China,' he says.

Booth points to Iranian offshore floating storage volumes so far in May as evidence of the squeeze. These have soared from 7mn to 20mn bl, 'although some of the VLCCs have switched off their transponders and a certain amount could be headed for Asia'.

During April, Iranian crude and condensate exports were around 950,000bl/d, the lowest level in 2019, down from 1.24mn bl/d in March, says Iman Nasseri, managing director for the Middle East at consultancy Facts Global Energy. However, 'only about half of those volumes were landed at destination by end-April, leaving about 450,000bl/d still on the water—they could arrive at a later date.' Tracking has its limitations as, once the transponders are switched off, the picture becomes hazy, although Iranian tankers have been seen switching their load to other carriers mid-ocean.

More upward pressure

'Taking all major uncertainties in the oil market—i.e. Iran, Venezuela, Libya, Nigeria, Opec+ output policy, the outlook for US oil production, plus the US-China trade talk—into account, in our base case we are still expecting some more upwards pressure on oil prices during the next few months, with dated Brent rising to a monthly average of $75/bl in August/September,' says Nasseri.

Despite some Iran exports, the oil market remains tight, he adds. Prices could push to $80/bl Brent at times during 3Q—'The market remains balanced, but tense. This assumes no military conflict.'

The impact of the Iran sanctions on a stand-alone basis can easily be handled given Opec's current spare capacity, says Robert Ryan at analyst BCA Research. However, 'any threat to Iraqi supplies, or talks of disrupting the Strait of Hormuz, will add to our prices forecasts'.

While rising US shale output does provide something of a cushion to global oil markets, it is not a substitute for the heavy-sour crude produced by Iran and Venezuela (and others), which is favoured by refiners with complex units. 'The loss of Iranian exports hits these refiners harder than those able to process lighter, sweeter crude of the sort exported by the US,' says Ryan. That explains why American WTI is trading at roughly a $10 discount to Brent.

But Goldman Sachs analysts say the oil price reflects 'much greater confidence in available spare capacity'. That view was echoed by the International Energy Agency, which believes 'global spare production capacity remains at comfortable levels'.

No-one doubts, though, that there are a lot of moving geopolitical pieces which could turn price forecasts upside down. 'A trade war resolution, a better economy coupled with Iran sanctions is a recipe for higher oil', says US bank BofA Securities in a note to clients. 'Under this scenario, one incident could trigger a spike in Brent to $100/bl.'

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