Crude Oil Bears Full Of Bull
“The sky is falling! The sky is falling!” the crude oil price bears are yelling from the woods.
We’ve certainly had several rough weeks in the market, with the price collapse at the end of last week especially ominous. Benchmark crude such as North Sea Brent and West Texas Intermediate (WTI) have given up over half their gains since rebounding strongly from their December lows. This is despite U.S. secondary sanctions disrupting a significant proportion of Iran’s oil exports as of May 1, contributing to the war drum beating louder in the Persian Gulf region.
Market players have instead become increasingly concerned about the health of the global economy, and hence oil consumption growth, primarily due to the Trump administration’s multi-front trade war, with last month’s escalation between the U.S. and China — the world’s two economic heavyweights — of greatest concern.
Geopolitics Central (GPC) has warned since President Donald Trump fired the first shot on solar panels and washing machines in January 2018 that the Sino-U.S. trade war was to be a permanent new feature of our New World Disorder, because in our view the major driver for America’s trade actions were geopolitical rather than economic.
We have argued this would negatively impact the trend rate of global economic growth, but not lead to a global economic recession, especially in the shorter term as both China and the U.S. continue to have significant policymaking tools at their disposal to combat slowing domestic growth.
Global oil consumption growth will be somewhat weaker than currently forecast by organizations such as the International Energy Agency (IEA), OPEC and the U.S. Energy Information Administration (EIA) due to slower than expected economic growth — see IEA Too Bullish On Global Oil Consumption – but GPC remains relatively bullish crude prices over the short term.
A number of geopolitically-inspired supply disruptions should make it relatively easy for OPEC+ to push crude prices to levels deemed acceptable to kingpins Saudi Arabia and Russia, despite continuing rapid growth in U.S. shale oil – crude and NGL – production.
The view that the primary motive of the Trump administration’s trade war with China is to preempt the further rise of a geopolitical rival is spreading, including among past and present Chinese government officials. For example, at a forum in Beijing on May 31, Zhou Wenchong, China’s ambassador to the U.S. from 2005 to 2010, said the biggest problem was whether the U.S. could accept and agree with “the development and flourishing of a socialist China.”
Last month, Trump upped the ante in the Sino-U.S. trade war, raising tariffs on US$200 billion of Chinese goods importing into America from 10 to 25 per cent, threatening tariffs on an additional US$300 billion of goods, and essentially banning Chinese telecom giant Huawei from doing business in the U.S. Beijing retaliated with tariffs on US$60 billion of goods imported from America.
The worsening trade war between the U.S. and China has contributed to economic forecasting organizations such as the International Monetary Fund (IMF) and Organization for Economic Co-operation and Development (OECD) to decrease their outlooks for global economic growth, and also has led them to explore the potential impact of a full-fledged trade war between the two economic heavyweights.
For example, in April the IMF downgraded its forecast for 2019 global economic growth for the fourth time in nine months. The IMF is now forecasting it at 3.3 per cent, compared to 3.5 per cent last year. Under a worst-case scenario, whereby the U.S. and China impose 25 per cent tariffs on all bilateral trade, the OECD is projecting global economic growth to be about 0.7 percentage points lower than otherwise in 2021 — GPC previously estimated a 0.6-point drop by 2020.
The global economic expansion may be long in the tooth at roughly a decade, and at risk with the Sino-U.S. trade war weighing, but, fortunately, the U.S. and China appear to have enough policy ammunition to help forestall a global recession for at least a few more years.
The Chinese government continues to have significant fiscal and monetary firepower, and has already announced a combination of tax cuts and increased infrastructure spending to boost the country’s economic growth rate. The U.S. is constrained fiscally, following Trump’s December 2017 tax cuts, but has some room to lower short-term interest rates following four rate hikes by the Federal Reserve last year and could, if need be, resort yet again to quantitative easing.
There has been much talk of an Iran War in recent weeks, given the end of waivers on U.S. secondary sanctions against Iranian crude and condensate exports at the beginning of May. But the likelihood of a war, whether intentional or accidental, is relatively small for the simple reason that the leaders of Iran and the U.S. don’t want one.
President Trump, who has been remarkably faithful to his campaign promises, to the chagrin of many, doesn’t want another Iraq-like war— a quick victory followed by a long defeat. Ayatollah Ali Khamenei, Supreme Leader of Iran, doesn’t want his revolution and country crushed by the massive military might of America.
This is not to say there aren’t powerful individuals in the Trump administration — such as National Security Advisor John Bolton and possibly Secretary of State Mike Pompeo — and regional allies — Israel, Saudi Arabia and United Arab Emirates (UAE) — who want a war to bring about regime change in Iran, and who are willing to stir the pot in an attempt to make it happen.
And despite an aversion to war with the U.S., it appears Ayatollah Khamenei has given Qassem Suleimani, leader of Iran’s powerful Quds Force and national hero, permission to encourage foreign militias aligned with Tehran to cause mischief for U.S. and allied forces in the Middle East, and if possible, disrupt the flow of oil from the region through non-attributed actions.
Although a massive disruption to oil supplies from the Persian Gulf region due to warfare may be relatively unlikely, U.S. secondary sanctions have already taken a significant amount of Iranian oil off the world market. The Trump administration has been gradually ramping economic sanctions on Iran since withdrawing from the 2015 nuclear deal — the Joint Comprehensive Plan of Action (JCPOA) — in May 2018.
Iran had been exporting roughly 2.7 million bbls/d of crude and condensate prior to America’s unilateral withdrawal from the international treaty, and one million bbls/d as recently as April. It has been reported Iranian exports collapsed to around 500,000 bbls/d in May with the end of U.S. waivers.
At the same time, there are a number of other geopolitical hotspots among oil exporting countries, especially Algeria, Libya and Venezuela, all OPEC members like Iran. Algeria, the producer of 1.02 million bbls/d of crude in April according to the IEA, has been in political turmoil since street protestors pushed President Abdelaziz Bouteflika from office in early April after 20 years in power. New presidential elections were to be held on July 4, but have since been cancelled, with mass anti-government demonstrations now in their fifteenth week.
Libya is again in civil war with forces loyal to General Khalifa Haftar, the de facto leader of the east and south of the country laying siege on Tripoli, home of Libya’s UN-recognized government, since early April. Mustafa Sanalla, head of Libya’s National Oil Corporation (NOC), has warned renewed combat has the potential of taking 95 percent of the country’s 1.17 million bbls/d of crude output offline.
Finally, Venezuela’s crude production continues its inexorable decline given the incompetence of the Maduro government and the inability of the opposition to dislodge the Chavistas from power. Venezuela produced 830,000 bbls/d of crude oil in April, compared to 2.4 million bbls/d in December 2015, and a record high of 3.2 million bbls/d in 1997 — the year before socialist firebrand Hugo Chavez first became president.
New World Oil Order
OPEC+ may not institutionalize to the extent previously planned, given concerns posed by potential U.S. anti-trust legislation — known as the NOPEC Act — but it still appears a permanent new fixture of the world oil order, in response to the U.S. Shale Oil Revolution.
This is not to say there aren’t differences of opinion between Saudi Arabia, the de facto leader of OPEC, and Russia, the leader of the non-OPEC members of OPEC+, especially in regards to the best target price for crude. The Saudis want the price of Brent in the US$80-$100/bbl range to help finance Crown Prince Mohammed’s (MBS) Vision 2030 economic plan and his Cold War with Iran — including the hot war in Yemen (see The Shocking Sanity Of Saudi Arabia’s $100 Crude Target).
In contrast, Russia appears to be targeting US$70 for Brent based on past government actions and comments by President Vladimir Putin. A price high enough to finance the country’s resurgent foreign policy but low enough to forestall even higher production growth from the U.S. and other non-OPEC+ countries.
As a result, it should come as no surprise that the Saudi and Russian views of rolling over OPEC+’s current 1.2 million bbls/d cuts into the second half of the year diverged when Brent was US$75 in April, but appear to have merged with Brent now testing US$60.
“We will do what is needed to sustain market stability beyond June,” said Saudi Energy Minister Khalid al-Falih to Arab News on June 3. He added that there was an “emerging consensus among OPEC+ countries, to continue their work towards market stability in the second half of the year.” On May 29, Russia's Deputy Prime Minister Anton Siluanov was the first to say his government was now considering an extension to the latest OPEC+ deal.
A rollover of the OPEC+ deal, along with continuing declines in Iranian and Venezuelan production, should be enough to not just balance the global oil market in the second half of the year, but to bring inventories down from what al-Falih referred to as “their currently elevated levels.” And this is despite oil consumption growth to be somewhat lower than currently predicted by the major oil forecasting organizations.
The IEA, OPEC and EIA are forecasting the call on OPEC crude to be between 30.2-30.5 million bbls/d in the second half, which may prove too high by 200,000-300,000 bbls/d given slower than anticipated economic and oil consumption growth. OPEC crude production was 30.21 million bbls/d in April, but as stated above Iranian oil production had already dropped by another 500,000 bbls/d in May alone.
GPC is now forecasting Brent crude to average US$70 this year, a substantial US$12.50 reduction from our November 2018 prediction given lower than anticipated prices so far this year. Brent is predicted to average US$65 in the first half, but to rebound to US$75 in the second with relatively little spare production capacity — below 2 million bbls/d — becoming an increasing concern of market players as geopolitically-oriented supply disruptions and Mideast tensions mount.