This is blog 2 in our 3 blogs on the US Mon morning announcement to not give any more waivers to import Iranian oil and condensate and to cut Iran’s exports to zero. No surprise, oil is up again after yesterday’s increase (WTI +$1.61 to $65.68, Brent +$2.07 to $74.04), but the question is will oil go higher still? It depends on three key questions – are there enough barrels to add to exports to offset Iran exports going to zero? If so, will the added export barrels be enough to bring oil prices down? What does it mean to put Iran’s back to the wall? Yesterday’s blog worked thru the math that shows US and OPEC+ added exports can closely match cutting Iran’s exports to zero. Today’s blog looks at the second key question, will the added barrels be enough to lower oil prices? If the new supply additions from US, Saudi Arabia, UAE and others only closely matches the Iran cut exports (assuming the US is successful in cutting to zero), we don’t think that is enough unless there is also a major release of oil from the US SPR and/or Saudi Arabia oil inventories. If not, we believe the normal seasonal oil supply/demand fundamentals and the risk of production losses from Venezuela and Libya point to oil prices still gong higher. We see near term oil going $5 to $10 higher. The third blog in our series will try to address what does it mean to put Iran’s back to the wall?
US and OPEC+ added supply can closely match a loss of ~1.4 mmb/d if Iran’s exports are cut to zero. Blog 1 of our 3 blogs on Iran sanctions was “Iran Sanctions – US Says No More Waivers, US/OPEC+ Can Closely Match Iran Exports To Zero” [LINK] and was written to see if US and OPEC+ can add enough supply to offset the loss of Iran’s oil and condensate exports if cut to zero exports. Based on IEA data, this would mean the loss of ~1.4 mmb/d of Iran oil and condensate from world markets. We certainly don’t mean to be wishy washy, but our conclusion is that the added US and OPEC+ supply potential will be close to matching the loss of Iran’s oil and condensate exports if they are cut to zero. The key wildcard is can the US cut to zero, and we note this at the end of this blog. But for the purposes of today’s blog, we have looked at the scenario of cutting Iran’s exports to zero.
Saudi Arabia increasing oil production in the summer doesn’t translate into a barrel for barrel increase in increased Saudi Arabia oil exports. Our first blog in this series noted that Saudi Arabia increasing oil production in the summer doesn’t translate into a barrel for barrel increase in oil exports. The reason is that the summer is the peak period for Saudi Arabia domestic demand for oil for electricity for air conditioning during the hot summer months. Last summer, Arab News (Saudi Arabia news) [LINK] story “Saudi Electricity Company explains rise in bills, invites unhappy customers to contact it” and “….according to bands of consumption in the residential sector, in addition to changing patterns of consumption in the summer due to a large increase in the use of air conditioners — 70% of electricity is consumed through the use of air conditioning equipment.” The Arab News story reminds that Saudi Arabia can’t increase exports on a barrel for barrel basis as any summer production increase because their domestic demand for oil goes up every summer to generate more electricity in the summer and Arab News says 70% of electricity is for air conditioning. This increased summer demand for oil for electricity is material. Below is the Joint Organisations Data Initiative data for Saudi Arabia’s oil and products demand, which shows that summer demand is ~500,000 b/d higher for electricity. Higher seasonal domestic demand means less oil for export.
Saudi Arabia Total Oil Products Demand
The math shows there has to be more supply – OECD oil consumption is estimated 0.8 mmb/d higher in Q3/19 vs Q2/19. The key reason why we believe the US/OPEC+ export increases just closely matching the loss of Iranian oil and condensate export barrels isn’t enough to bring down oil prices is that global oil demand (not just Saudi Arabia domestic demand) is always higher every summer. Rather, under a closely matching scenario, we expect oil prices still go up another $5 to $10. The increasing summer oil demand is not a 2019 event, rather it is the normal seasonal increase in OECD oil demand that happens every year. Last year, OECD Q3/18 oil demand was 0.9 mmb/d more than Q2/18, and this year, the IEA forecasts OECD demand to be 0.8 mmb/d in Q3/19 vs Q2/19.
International Energy Agency World Oil Demand Forecast
A major release from US SPR/Saudi oil inventories is needed to fill the supply gap and keep oil prices from moving up too much higher. Prior to any additional or new oil supply interruptions from Venezuela and Libya, its hard to believe the US sees the math much differently on replacing Iran’s exports if cut to zero ie. the added US and OPEC+ exports (not production) can basically offset a complete loss of ~1;4 mmb/d of Iran oil and condensate barrels. Our concern is that just offsetting the loss of Iran’s exports isn’t enough to keep oil prices from going up. At the same time, the US (and Saudi Arabia in particular) have to be well aware of the increasing global oil demand that happens every summer. The US has been careful to not indicate that any of the oil to replace the Iran exports is coming from the US Strategic Petroleum Reserve. Rather, we believe they are saving this in reserve in the event they need to release oil to bring oil prices lower or in the event of a supply disruption in Libya or Venezuela. Similarly, Saudi Arabia has not given any indication if they will reduce oil inventories to supply the needed export volumes. But the increasing seasonal oil demand is a reason in itself why we believe a release of US SPR and/or Saudi Arabia oil inventory is needed to keep oil prices from moving up too much higher in the near term. We still see oil prices moving up from here unless there is a major release of oil from inventories.
Iran maintaining some exports shouldn’t be enough to stop oil prices from moving up higher. As noted earlier, we have looked at the impact assuming the US is successful in cutting Iran’s oil and condensate exports to zero ie taking ~1.4 mmb/d of oil and condensate off the export market. The expectation seems to be building that Iran will be able to maintain some level of exports ie. up to 500,000 b/d. If so, this will help, but not be enough to fill the supply gap from higher seasonal oil demand. However, it should keep oil prices from moving too much higher. This assumes the reason for some Iran oil exports is not the US giving waivers at the last minute. We believe a repeat of the Nov surprise last minute waivers could cause a backlash.
There is still the risk for continued Venezuela crumbling oil production. Venezuela oil production has crashed being just over 700,000 b/d in March. At these levels, there is still risk for more Venezuela oil declines, but not to the same magnitude as seen in the past two years. The biggest predictable factor that has driven 2019 oil price strength has been how the deterioration of Venezuela under Maduro, accelerated by US sanctions and regular electricity blackouts, would lead to a continued crumbling of Venezuela’s oil production. Power outages are a huge issue as power is needed at all phases of the oil supply chain from producing wells to field processing and upgrading to pumping stations for pipelines to terminals for export. And a key factor is that Maduro is quickly depleting Venezuela’s gold and cash reserves, which are needed to fund the fight to stay in power and also to keep critical electricity infrastructure operating. Our April 14, 2019 Energy Tidbits memo noted that Venezuela’s dwindling gold reserves and how, at 2019 burn rate of ~$0.45b/mth, its >$4b gold reserves will be gone by year end 2019. Our April 21, 2019 Energy Tidbits noted that Venezuela’s international reserves fell to $8.59b on April 12, which is down $1.33b YoY from $9.92b at April 30, 2018. The low YoY cash burn was only minimized because Maduro is burning thru his gold reserves at a faster rate. Maduro took over on Apr 19, 2013, and Venezuela’s international reserves were $27.59b on March 31/13. That means he has burnt thru $19b in 6 years, or $3.2b/yr or $0.26b/mth. Venezuela’s financial position is rapidly deteriorating impacting the economy and oil. OPEC MOMR Secondary Sources estimated Venezuela March 2019 oil production was 0.732 mmb/d, which is less than half of March 2018 oil production of 1.478 mmb/d. Venezuela is pulling out all available stops to minimize further oil production declines, but Venezuela remains a continued upside risk to oil prices with US sanctions having an increasing impact.
Venezuela Oil Production
Libya is a new increasing risk – there are multiple events that could lead to interruptions in Libya’s oil and gas exports. One of our concerns with the ramp up in production from Saudi Arabia, UAE, Iraq, etc is that it means there is very little surplus oil capacity left to fight off the impact of any significant supply interruption. And we believe a Libya oil and gas supply interruption is inevitable, the only question is how much and how long. We see increasing momentum for Haftar to ultimately take over control of Tripoli and western Libya. Fighting has escalated for Tripoli, but, so far, Libya has been able to hold Haftar to a bit of a stalemate at the southern outskirts of Tripoli. However, we don’t see Haftar will quit in his push to take over Tripoli and western Libya. Our biggest concern for Libya is that they don’t seem to have any big international champions fighting their cause against Haftar. And they certainly don’t have a Maduro type situation, where Russia is doing all they can to resist the US led move for regime change. Libya just doesn’t have that, whereas Haftar has a number of large regional (Egypt, Saudi Arabia, UAE) and international (US, Russia) supporters. There are multiple ways to see an interruption to oil and gas exports. Fighting escalates west of Tripoli and impacts oil and gas export terminals. Libya tries to counter attack again in southwest Libya and it ends up enveloping the 315,000 b/d Sharara oil field in another shutdown, or perhaps even a counter attack somewhere else. Electricity blackouts are increasing but have not yet impacted electricity to the oil and gas supply chain in Libya. Plus, we can’t forget the interesting stand off potential in Libya as Haftar has control on all major Libya oil fields, whereas the international community only does transactions with Libya and the Libya National Oil Corporation. If Haftar wins, will the international community change its position and recognize the new Haftar Libya and Libya NOC? if so, then the supply interruption could be minimal in time. The push for international recognition will be helped by Trump’s support for Haftar. It is also a reminder that Haftar has the ability to shut in production at any time if he wants to squeeze Libya.
Libya Oil Production
And all of this is before the new wildcard of what does it mean to put Iran’s back to the wall? The US move to eliminate Iran’s oil and condensate exports is pushing Iran to another level. If successful, it will cut off ~$85 million a day in revenues. The US Iran playbook seems like its Venezuela playbook of tightening sanctions (effectively a semi siege) and hope that the deteriorating economic conditions get so bad the people end up forcing a regime change. Will the people rise up in another Iran revolution to force regime change? But until or if that event, we have to wonder what the ruling regime will do to respond as we don’t think they will just simply give in to US wishes. Putting Iran increasingly under pressure is a bigger focus than the US’s similar strategy in Venezuela. Its not just Iran’s threat that if their oil can’t get to market via Strait of Hormuz, then others oil also won’t go out thru the Strait of Hormuz. Iran’s production, strategic location and influence in the region make Iran a much bigger risk factor to oil prices. How Iran responds in the coming weeks and months will be the key focus item for oil prices. The result of the stepped up US actions is simple – it adds an increasing geopolitical risk to oil prices related to Iran. The third blog in this series should be out either tonight or Wed morning on this question.