The United States is banking on increased production out of Saudi Arabia and the United Arab Emirates to substitute for the loss of Iranian supply from the decision not to extend waivers from U.S. sanctions against dealings with Tehran.
“Saudi Arabia will coordinate with fellow oil producers to ensure adequate supplies are available to consumers while ensuring the global oil market does not go out of balance,” Saudi energy minister Khalid Al Falih was quoted as saying following the overnight reports – later confirmed by the White House – waivers granted to eight nations in November 2018 that are expiring in the next few weeks will not be renewed. The waivers allowed the eight countries – China, Greece, India, Italy, Japan, South Korea and Turkey – to continue importing Iranian oil without fear of coming under U.S. sanctions for doing so.
The support of the UAE was claimed in the official statement by the Trump White House.
Those two countries have slashed their output in recent months as part of the broader agreement reached in December between OPEC and a group of other nations, led by Russia, to reduce supply. If those two countries alone reversed their cuts and went back to what they produced in November 2018 – based on numbers published by S&P Global Platts – that could tack on 1.4 million barrels per day (b/d) of additional supply that replace Iranian cutbacks, made necessary as their list of customers dries up.
In November 2018, Saudi production was just over 11 million b/d, a record. In that same month, the UAE produced 3.3 million b/d, according to Platts. But in March, the Saudis were down to 9.87 million b/d and the UAE was down to 3.05 million b/d. Add those together and you get about 1.4 million b/d of cuts since November. That’s before any other countries are counted, including the cuts out of Russia, which have been estimated at anywhere from 150,000 b/d to 200,000 b/d.
Since that December OPEC meeting, Venezuelan production has slipped into freefall. The Platts’ estimates of Venezuelan production for November 2018 were about 1.1 million b/d. For March, they were at around 750,000 b/d. Libyan civil war also has led to an output drop, though that country’s production for years has been marked by constant increases and declines, all within months of each other. Reduced supplies out of those two countries can not simply be easily restored to makeup for lost Iranian barrels and they could get worse.
But the decision by the U.S. not to extend the waivers was clearly driven by the Saudi and UAE cooperation, not an assumption that other nations would restore their cuts as well. As President Trump said in a tweet Monday, “Saudi Arabia and others in OPEC will more than make up the Oil Flow difference in our now Full Sanctions on Iranian Oil.” And this is from the same Twitter feed that repeatedly has been used to advocate that OPEC increase output even as expiration of the waivers threatened a reduction in supply.
Just how much will need to be restored is far from certain. Current Iranian production is about 2.7 million b/d, down a bit more than 1 million b/d from the average 2017 level, the last full year in which there were no sanctions. The country consumes about 1 million b/d internally, leaving exports at about 1.7 million b/d.
Overall, the drop in OPEC supply from the 33.08 million b/d that Platts said OPEC produced in November is 2.8 million b/d. That number, though, includes Qatar, which produces about 600,000 b/d and is no longer in OPEC. That takes the overall OPEC decline down to 2.2 million b/d, still more than enough if fully restored to cover the worst-case drop in Iranian exports.
Despite U.S. proclamations, the general sentiment in the market is that zeroing out Iranian exports will not occur. The question going forward then is what share of the 1.7 million b/d in exports will be threatened by the end of the waivers and how much can continue to move into world markets despite the “full speed ahead” implementation of the sanctions?
What will happen in the market, though, is not just a function of what is often derided as “counting barrels,” a form of analysis that is considered simplistic by some critics. The oil market faces three clear risks now: the end of the waivers; the uncertain fate of Venezuelan and Libyan output; and a push to higher prices led by factors related to the implementation of IMO 2020 at the start of next year. That latter factor does not appear to have increased any product prices yet but various grades of crudes with properties compatible with manufacturing new grades of marine fuels created by the IMO 2020 regulation have risen relative to international benchmarks.
Take those three together and there is a large element of fear injected into the market. As energy economist Philip Verleger said in a report issued Monday, “The oil market today is psychologically out of balance. The process of hoarding has begun.” His evidence for that comes in the shape of the forward curve, which has moved into a roughly $3 backwardation between June 2018 and January 2019, where the June price is $3 more than January. That is a sign of tightening inventories or as Verleger would put it, hoarding.
Prices on Monday did rise sharply as would be expected following the late Sunday news. But they closed at levels less than their intra-day peak number. The White House statement affirming the Saudi/UAE report, which promises new supplies, did take some air out of the market. By the end of the day, Brent crude had risen approximately 3 percent while WTI on CME was up about 2.5 percent, not surprising given that Brent would be expected to carry global sentiment more fully than the domestic WTI contract. Good news for truckers – the ultra low sulfur diesel contract on CME was up only 1.66 percent, the laggard among the benchmarks.