Neither Stratosphere Nor Depths For Global Crude Prices

A correction in international benchmark crude prices turned to an historic rout with the market caught flatfooted early this month by the Trump administration’s announcement of waivers on reintroduced U.S. economic sanctions for eight significant purchasers of Iranian oil.

Brent and West Texas Intermediate (WTI) prices at US$85 and US$75/bbl, respectively, and trending higher in early October, were primarily the result of Trump’s stated policy of “maximum pressure” towards Iran. Rising production from Saudi Arabia, Russia and a few other countries to make up for lost Iranian volumes was expected to push global spare capacity to a barebones one million bbls/d or less by early next year (see Crude Oil Prices To The Stratosphere?).

Instead, projections by the leading oil forecasting organizations — International Energy Agency (IEA), U.S. Energy Information Administration (EIA) and OPEC — now suggest production cuts in the one million to 1.5 million bbl/d range are needed to balance the world oil market next year.

The primary driver for the original crude price correction was rising concerns about the health of the global economy, and hence oil consumption growth. Spot WTI declined from a four-year high of US$76.40/bbl on October 3 to US$63.12 on November 5, the day the Trump administration announced its Iranian oil exemptions, for a decline of 17 per cent.

There are plenty of reasons to be worried about the world economy — including massive debt in the system — but a significant slowdown in growth, or even a recession, is likely at least a few years away. The global economic expansion is long in tooth, approaching a decade, one of the longest since the Second World War, with interest rates again rising — albeit gradually — in the U.S., still the epicenter of global finance.

The Sino-U.S. trade war is already weighing on the Chinese economy, the largest oil importer in the world, with economic growth slowing to 6.5 per cent in the third quarter, the slowest rate since the depths of the 2008-09 global financial crisis. But the Chinese government continues to have significant fiscal and monetary firepower, and has already announced a combination of tax cuts, increased infrastructure spending and looser monetary policy to boost the country’s growth rate.

And in early October, prior to the precipitous drop, the IEA was warning high crude prices were posing a threat to the global economy, while at the same time denting oil demand growth in some of the world’s fastest growing economies through higher end-use prices. “Expensive energy is back at a bad time when the global economy is losing momentum,” said Fatih Birol, the agency’s executive director. “We really need more oil.” This threat has to a degree, and at least temporarily, been alleviated.

Spot WTI dropped an additional US$7.49/bbl following the Trump administration’s Iran waiver announcement, culminating in a massive US$4.22 single day decline to US$55.63 on November 13 — a record 12th consecutive day in the red — for a total drop of 27 per cent. Prices have since rebounded modestly, primarily due to the Saudis announcing a 500,000 bbl/d reduction in sales for December.

Looking forward, an agreement of some sort is likely needed to remove at least another one million bbls/d from the global oil market at next month’s meetings of OPEC and OPEC+ — the 14 OPEC members plus 10 non-OPEC countries that have managed their crude production since the beginning of 2017 — in Vienna to support crude prices.

But, as of now, there appears to be a disconnect between the price aspirations of Saudi Arabia, the de facto leader of OPEC, and Russia, the leader of the non-OPEC members of OPEC+. The Saudis want the price of Brent crude in the US$80/bbl-$100/bbl range, as reported by Reuters in mid-April (see The Shocking Sanity Of Saudi Arabia’s $100 Crude Target).

The Kingdom needs higher crude prices to finance Crown Prince Mohammed’s (MBS) Vision 2030, a plan to diversify the economy away from oil revenue in the longer term and create private sector jobs for the country’s rapidly rising population, and to finance its Cold War with Iran, including the hot war in Yemen. On November 12, Saudi Energy Minister Khalid al-Falih recommended OPEC and its non-OPEC partners collectively slash output by one million bbls/d next year, while a figure of 1.4 million bbls/d has since been tossed around.

In contrast, the Russian government appears to be targeting US$70/bbl for Brent based on a recent comment by President Vladimir Putin, not much higher than current prices, contributing to a reluctance to agree to new output cuts, especially as the future level of Iranian oil production and exports remain in doubt. The Trump administration’s waivers are only for six months, and it could decide to significantly tighten them for some or all of the eight countries in early May of next year.

Russian production hit a post-Soviet high of 11.41 million bbls/d in October, 460,000 bbls/d more than the 10.95 million bbls/d target it had originally agreed to under the 2017 OPEC+ supply pact, before agreeing in June to reverse course to make up for lost Iranian  — and Venezuelan — production. Al-Falih suggested October’s production levels as the reference point for his proposed collective cut, whereas Putin said last month that Russia could add another 200,000-300,000 bbls/d to its production, making a freeze more likely than a cut for the Russians.

Despite his continuing tweets on the subject, Trump is likely to have less success dampening world crude prices moving forward as his sway over MBS, de facto leader of Saudi Arabia, has likely declined. The Trump administration may continue to support the Crown Prince, given their informal alliance against Iran and military arms sales, but U.S. Congress appears far less forgiving over the Khashoggi affair, especially now that the CIA has implicated MBS in the journalist’s brutal murder. At the same time, the Crown Prince may feel hoodwinked by Trump. Saudi Arabia ramped up crude production by roughly 500,000 bbls/d to make up for Iranian oil lost to the global market by tough U.S. sanctions, not to crash world oil prices.

In retrospect, Geopolitics Central was wrong to boost our WTI price forecast for 2018 and 2019 in early July, based on the belief that the Trump administration would strictly enforce its reintroduced economic sanctions on Iran. Frankly, we should have known better, especially since we predicted Trump would ultimately prove pragmatic on the North American Free Trade Agreement (NAFTA), leading to a successful renegotiation of that treaty. The Trump administration has been surprisingly pragmatic at times, contrary to Trump’s extreme rhetoric.

As a result, Geopolitics Central is now forecasting the price of WTI to average US$66.25/bbl this year and US$77.50/bbl in 2019 — a reduction of US$6.25/bbl and US$7.50/bbl, respectively. This assumes an agreed production cut of at least one million bbls/d by OPEC for next year, possibly with support of some of its non-OPEC partners, and no more than a moderate tightening of America’s Iran sanctions next May.