The oil price rally has failed to gain any kind of momentum three weeks after tensions in the Middle East escalated despite market fundamentals strengthening. Brent crude for December delivery was down 1.8% to trade at $88.49 per barrel at 1400 hrs ET in Thursday’s intraday session while the December WTI contract fell by a similar margin to change hands at $83.88 per barrel. Brent has now declined 7.0% over the past week while WTI is down 4.8% over the timeframe as worries about the global economy and energy demand weighed on sentiment.
Oil prices have been a rollercoaster over the past couple of months as negative catalysts frequently outshine the positive ones and vice-versa. In recent times, fears of a spillover in the conflict between Israel and Hamas, which could embroil Iran and its allies in the region, have offered considerable support to oil prices. However, the U.S. and other countries have been urging Israel to delay a full invasion of Gaza, which the Middle East nation has so far complied with.
Meanwhile, global oil supply has continued tightening despite record production by U.S. shale. The latest Energy Information Administration (EIA) weekly data was highly bullish with crude oil inventories falling 4.49 mb to 419.75 mb, taking the deficit below the five-year average to 20.91 mb. Crude oil inventories in the WTI pricing hub at Cushing, Oklahoma, fell 0.76 mb to a nine-year low of 21.01 mb. Meanwhile, gasoline inventories fell 2.37 mb to 223.90 mb, thereby cutting the surplus above the five-year average to just 0.40 mb. Implied demand improved significantly w/w, with total demand climbing 2.231 mb/d to 21.897 mb/d and gasoline demand rising 362 kb/d to 8.943 mb/d. Gasoline demand for October-to-date stands at 8.792 mb/d, a mere 0.2% Y/Y contraction and good for a sharp improvement from the 5.6% decline Recorded in September. Gasoline demand is 0.4% higher in the year-to-date.
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Even better, commodity analysts are predicting that oil markets will continue to tighten for the rest of the year.
Commodity analysts at Standard Chartered have predicted a further 120 mb reduction in global inventories in Q4, on top of the 172 mb reduction in Q3. The experts expect the rate of inventory draw to accelerate from 0.52 mb/d in October to 1.38 mb/d in November and 1.99 mb/d in December. StanChart says it’s possible that the current dominance of Middle East headline trading has led to lower prices by distracting the market from both falling inventories and from producer policies aimed at achieving a soft landing for the market at higher price levels. In other words, the recent tendency towards higher prices with lower volatility has been replaced by a downwards drift with higher volatility.
That’s a remarkable trend considering surging U.S. production. Data by the U.S. Energy Information Administration (EIA) shows that U.S. crude production grew 0.7% to 12.99 million barrels per day (bpd) in July, its highest since November 2019, when production hit a peak of 13 million bpd. Texas production grew 1.3% to 5.6 million bpd in July, its highest on record; North Dakota's output increased 1.2% to 1.2 million bpd while production from New Mexico climbed 0.6% to 1.8 million bpd.
The demand side of the equation is equally encouraging. According toStanChart, global oil demand has already exceeded the pre-Covid oil demand set in August 2019, averaging 102.33 million barrels per day (mb/d), good for a m/m increase of 1.2 mb/d and a y/y increase of 2.3 mb/d. The analysts have refuted arguments by some Wall Street analysts that high oil prices have already triggered demand destruction.
Underpricing Middle East Risk
Last week, Standard Chartered pointed to a medium-term reduction in Iranian oil exports as being the most likely consequence of shifts in the geopolitical landscape. It’s not a far-fetched notion either: last week, the Biden administration slapped new tariffs on Iran due to its ballistic missile and drone programs.
Back in August, we reported that Iran's oil exports had hit record highs thanks in large part to the Biden administration opting to look the other way as Tehran boosts production ostensibly in a bid to keep markets well supplied and oil prices low. The price response to the escalation in the Middle East tensions has so far been modest; however, the Israel-Gaza war is likely to cause a significant shift in U.S. policy on Iran due to its open support and backing for Hamas.
Constraints on Iranian oil exports were eased after the signing of the Joint Comprehensive Plan of Action (JCPOA) in 2015 but tightened again after the U.S. withdrew from the JCPOA during the Trump administration, with output falling below 2 mb/d in 2020 when waivers given to consuming countries were withdrawn. Iran’s oil output and exports have increased sharply under the Biden administration, with production hitting 3 mb/d, including 500,000 b/d in the current year, while exports sit just under 2 mb/d.
StanChart says that changes in positioning in the oil futures markets have been modest despite a significant increase in volatility. The analysts note that it is not an extreme tail of the distribution as might be expected in a full-blown Middle East crisis, adding that speculative positioning is also not extreme, particularly in Brent. The latest fund manager data shows that prices are about USD 6 per barrel (bbl) lower than in late September, despite no significant loosening in fundamentals. StanChart says that the Middle East geopolitical risk is currently being significantly under-priced and that current fundamentals alone are enough to justify a complete reversal of this month’s price undershooting.
By Alex Kimani for Oilprice.com
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In fact Brent crude hit $97 a barrel after the Hamas-Israel erupted war but declined a bit after fears of a wider war in the Middle East didn’t materialize. This isn’t to say that things couldn’t change in minutes if Iran got involved in the conflict.
With solid fundamentals and a tight market, it could take Brent crude only a few seconds to hit $100 a barrel if Iran and its allies decide to join the fight against Israel.
However, with the ongoing stalemate between Israel and Hamas, Iran finds itself as the determinant of war or peace in the Middle East.
Any direct or indirect involvement by Iran in the conflict will lead to wider war in the Middle East and a disruption of energy supplies but only if Iran succeeds in blocking the Strait of Hormuz. If it does, Brent crude could even rise to $150 but it won’t stay there for long because of measures the United States will take to clear the Strait and because of global oil demand destruction.
However, I tend to discount the possibility of a direct involvement by Iran or even an indirect one involving Iran’s allies: Hizbullah, Hamas and Syria.
Iran knows full well that the United States and Israel are looking for an excuse to attack and destroy its nuclear installations. It doesn’t want to provide them with one.
There is, however, the possibility that both the United States and Israel could invent an excuse to attack Iran. In such a situation war will be forced upon Iran with implications affecting the whole Middle East and also the entire global energy scene.
Dr Mamdouh G Salameh
International Oil Economist
Global Energy Expert