Oil: "Our production, your problem"

06/21/2019 | 10:56am

"Our production, your problem" to paraphrase the good word of Nixon's Treasury Secretary John Connally when he replied to Europeans who criticized the fluctuations of the greenback: "The dollar is our currency, but it is your problem".

Regularly commented on in this section, geopolitical tensions in the Middle East are reaching a new stage after the alleged attack by two tankers in the Gulf of Oman, near the strategic strait of Hormuz (read here: Two tankers "attacked" near the strait of Hormuz). The United States and Iran are passing the buck on their responsibility for this incident, further increasing mistrust between the two countries. These events followed the sabotage of four other oil tankers off the United Arab Emirates, as well as the intensification of drone attacks by Houthi militias, supported by Iran, against Saudi infrastructures.

This region of the world should thus continue to focus the attention of financial operators and traders. The stakes remain high as the Strait of Hormuz is the most important waterway for crude oil trade. Almost a third of the world's production passes through it, a vital axis for many producing countries. As such, all oil exports from Kuwait, Iran, Qatar and Bahrain, as well as a very large part of those from Saudi Arabia, Iraq and the United Arab Emirates, pass through this strait.

Still on the geopolitical front, Tehran has indicated that the ceiling for low-enriched uranium set by the Vienna agreements will be exceeded in a few days, thereby reducing Iran's nuclear commitments. At the same time, Washington is increasing its presence in the Middle East by increasing its military strength by 1000 soldiers.

Naturally, these geopolitical frictions tend to create pressure on crude oil prices, which, paradoxically, have struggled to maintain an upward trajectory since early May.  To disentangle this misunderstanding, we must focus on market fundamentals, which are still depressed by fears of an abundance of oil. The dynamics of crude oil inventories rightly crystallize these concerns, as they are unable to fall below their five-year average.

Evolution of US stocks - source EIA

More specifically, crude oil stocks remain significantly higher than last year's levels, a fact that can be observed both in the United States and globally in OECD countries. This dynamic is all the more worrying because, at the same time, OPEC and its allies are working hard to contain global supply, in addition to the gradual withdrawal of Iran and Venezuela, whose production is falling sharply due to sanctions and economic difficulties.

That is why we are convinced that there are structural problems that prevent the rebalancing of the oil markets. The devil would probably hide on the demand side. As such, both the EIA and OPEC have revised their demand growth forecasts downwards in their latest monthly reports. Not surprisingly, trade tensions are being pointed out, as well as their consequences on global growth.

The second culprit is obviously the rise of the American shales, which are crossing new production levels every month. The EIA forecasts that U.S. production will increase by 1.36 million barrels per day (mbd) in 2019 and 0.94 mbd in 2020, with an average production of 13.3 million barrels per day in 2020.

US production forecast and contribution by region - source: EIA

Although the sustainability of US shale oil growth in the coming years divides experts, one thing is certain, the United States enjoys a position of superiority in the oil markets. The evolution of U.S. crude oil exports reflects this growing supremacy. The United States exports nearly 3 mbpd to 27 different destinations. In order to appreciate the power of this dynamic achieved in a few years, it should be borne in mind that Saudi Arabia exports a little over 7 mbpd.

This is obvious, American producers are conquering market shares and have a wide range of weapons at their disposal to carry out this expansion (read here: When the United States breaks the oil market). Far from American considerations, market balance is not their problem, but it is precisely that of the other producing countries.

Evolution of US crude oil exports and distribution of destinations - source: EIA

In this context, the market has high expectations of OPEC, or rather of OPEC+, which includes Russia. The enlarged organization effectively assumes the role of a "swing producer" with the mission of regulating supply and supporting price stability. The next cartel meeting will thus be decisive, especially as it will result in a renewal of oil quotas, reducing the world supply by 1.2 mbd. 

If this meeting were initially scheduled for June 25 and 26, the schedule could be reviewed at the request of some countries, notably Russia and Saudi Arabia, which do not wish to interfere with the G20 meeting at the end of the month. Nevertheless, other countries, including Iran, strongly oppose it, adding beyond the confusion, an additional degree of tension within OPEC+. If the simple choice of meeting date is a matter of contention, which will finally take place on July 1 and 2, then the meeting promises to be stormy.
Jordan Dufee
MarketScreener.com 2020
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