Analysis: Crude Oil Prices To The Stratosphere?

There is a damned good reason international benchmark crude prices have been rocketing higher since so-called OPEC+ —  the 14 OPEC members and 10 non-OPEC countries restricting crude production since the beginning of 2017 —  agreed to raise output on June 22: a potential supply crunch late this year or early next year due to yet another misguided policy by U.S. President Donald Trump.

On June 26, the U.S. State Department announced that companies from around the world would have to totally phase out the import of Iranian crude oil and condensates by November 4 — 180 days after Trump pulled the U.S. out of the 2015 Iran nuclear deal and renewed powerful U.S. financial sanctions – or pay the piper. This puts up to 2.7 million bbls/d of Iranian crude and condensate exports at risk, similar to current global spare capacity, and far greater than the 300,000-450,000 bbl/d figure Geopolitics Central had pencilled in for lost Iranian production next year due to renewed sanctions.

Presently, on paper, there is roughly 3.5 million bbls/d of spare crude capacity worldwide, with OPEC kingpin Saudi Arabia leading the pack at 1.5 million bbls/d, non-OPEC kingpin Russia with 500,000 bbls/d, and most of the rest distributed among several other Persian Gulf countries.

But it is important to note that most, if not all, of Kuwait’s 290,000 bbl/d of spare is in the Neutral Zone with Saudi Arabia and offline for environmental reasons and Iraq’s 220,000 bbl/d of spare is embroiled in dispute with the Kurds in the north. Hence, effective global spare crude capacity is more like three million bbls/d, marginally higher than the crude and condensate under risk from forceful implementation of renewed U.S. financial sanctions on Iran.

At the same time, Venezuela’s crude production is in free fall, with GPC forecasting it to decline by 500,000 bbls/d this year — it is down 210,000 bbls/d in the year to May — and the same amount again next year, with production continuing to slip in Angola and precarious in a number of other OPEC countries such as Libya and Nigeria for geopolitically-related reasons (see Top Geopolitical Hotspots For Crude Oil Through 2019).

There is every reason to believe that Saudi Arabia, Russia and other OPEC+ countries will do everything in their power to keep crude prices from hitting the stratosphere given the damage US$100 plus crude has done to the global economy and oil consumption in the past. The outcome of the recent meeting supports this notion. Although somewhat opaque, OPEC said it would go back to 100 per cent compliance on its agreed 1.2 million bbls/d of cuts, suggesting 770,000 bbls/d of additional production, but Saudi Arabia indicating a figure around one million bbls/d.

More importantly, Saudi Arabia issued a statement the same day that the Trump administration slapped fresh sanctions on Iran in May that it was prepared to meet any resulting supply shortage — not surprisingly, given the geopolitical rivalry between the two countries in the Middle East — while Russia has hinted the same.

It has been widely argued that Saudi Arabia capitulated to Trump’s demand to bring down crude prices with its actions at the OPEC+ meeting, but GPC continues to believe that the Kingdom is targeting US$80 to US$100 per bbl oil (see The Shocking Sanity of Saudi Arabia’s $100 Crude Target). “Looks like OPEC is at it again,” Trump wrote in a Twitter post in mid-April. “Oil prices are artificially Very High! No good and will not be accepted!” Subsequently, the U.S. government is believed to have asked Saudi Arabia to encourage a one million bbl/d production increase, the figure cited by the Saudis after the June 22 meeting.

However, Crown Prince Mohammad is the master of manipulating Trump, whether by treating him like royalty during his visit to Riyadh in May 2017 or simply letting him play with a sword in a Saudi line dance. The Crown Prince has plenty of reasons for wanting and needing higher crude prices including: the upcoming IPO of a small stake in Saudi Aramco; to finance projects related to Vision 2030 to diversify the economy away from oil revenue; the Kingdom’s ongoing war in Yemen; and to maintain the social contract with his subjects during a period of rapid social and economic transition.

Fortunately, for the sake of the global economy and world oil market, U.S. financial sanctions are unlikely to totally stop Iranian crude and condensate exports for two reasons, possible waivers and leakage. The Obama administration prudently used widespread waivers to avoid shortages of crude — previous U.S. sanctions did not include condensate — and an oil price spike, and as a result, Iranian crude exports were cut by only around 1.5 million bbls/d at their height.

But, frankly, significant waivers are unlikely this time around with the U.S. State Department already explicitly stating no plans to grant them to any companies, which is not surprising given Trump’s general lack of prudence and his administration’s more aggressive goal vis-à-vis Iran — regime change, rather than simply curtailing the Islamic Republic’s nuclear weapons program.

In terms of potential leakage, Chinese companies would appear to be the most likely evaders of U.S. sanctions on Iran, especially with Chinese-U.S. relations rapidly deteriorating anyways due to the Trump-inspired trade war. But even Chinese companies have to be concerned about losing access to U.S. dollar based payments systems, which can hamper their ability to do business internationally.

China has been importing roughly 650,000 bbls/d of Iranian crude and condensate in recent months, and could potentially import substantially more, especially as Iran is likely to discount prices in an attempt to evade sanctions — China is already Iran’s largest customer. The next most likely sources of significant leakage are covert shipments through Iran’s neighbouring allies Iraq and Russia.

It is important to note that the Trump administration may be counting on releases from the U.S. Strategic Petroleum Reserve (SPR) — and possibly strategic reserves from other member countries of the International Energy Agency (IEA) and non-IEA countries such as China and India — to make up for a global shortfall of crude over the short to medium term to avoid a massive spike in oil prices primarily due to its renewed sanctions on Iran.

In May 2017, the Trump administration proposed cutting the amount of crude oil in the U.S. SPR by half — to roughly 345 million bbls — for no other reason than a lack of U.S. need given rapidly rising domestic crude production and declining dependence on foreign oil. The U.S. government has since announced a plan to sell 100 million bbls between the years of 2022 and 2027.

To conclude, GPC is now conservatively forecasting spot WTI to average US$72.50/bbl this year, a US$7.50 bump from our April forecast, and US$85 in 2019 — US$15 higher than previously (see Crude Prices to Strengthen Through Next Year). After averaging around US$65/bbl in the first half of 2018, we are projecting WTI to end this year at US$80 and next year at US$95/bbl, with the potential of substantially higher crude prices if the world runs low or out of spare production capacity and releases from strategic reserves fail to calm the market.