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Nick Cunningham

Nick Cunningham

Nick Cunningham is an independent journalist, covering oil and gas, energy and environmental policy, and international politics. He is based in Portland, Oregon. 

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The Silence Before The Storm In Oil Markets

With oil production plunging in Venezuela and Iran, tension in the Middle East at its highest point in years, and the threat of further outages in Libya, why are oil prices not trading higher?

Even price volatility has been rather low, a surprising feature of a tight market rife with geopolitical risk.  Brent crude has been stuck between a relatively narrow range of $70 to $75 per barrel for more than a month, despite all the turmoil.

Furthermore, even the back end of the futures curve has barely budged, trading between $60 and $65 per barrel. At the same time, the front end of the curve has moved into steep backwardation – when near-term contracts trade at a premium to longer-dated futures. Backwardation is typically associated with a tight oil market – essentially, traders are willing to pay a premium for oil today relative to deliveries six or twelve months out.

What does all of this mean? “The recent movements in the oil price complex indicate some deep dislocations between the physical and futures markets and in market expectations about current and future oil market fundamentals,” the Oxford Institute for Energy Studies (OIES) wrote in a new report.

Last year, the oil market saw the opposite situation occur. The back end of the curve rose in anticipation of a tighter market while the near-term futures suggested the market was well-supplied, OIES noted. That discrepancy was sorted out when a wave of supply came online from OPEC+, the U.S., and the Trump administration gave surprise waivers to Iran. The end result was a crash in prices.

How will the gap in expectations be resolved this time around? “If 2018 is a good guide, the price level will eventually increase to reflect the current tightness in the physical market,” OIES said. The significant outages in Venezuela and Iran, the oil contamination problems in Russia, the potential for disruptions in Libya and the slowdown in the U.S. shale industry all point to increasing tightness. Related: Bearish EIA Data Sends Oil Lower

The big question is how and when Saudi Arabia will respond. Riyadh is very reluctant to see a repeat of 2018 when prices crashed following production increases. This time around Saudi Arabia will err on the side of letting the overly tighten, although the OPEC+ group has adopted a “wait-and-see” approach, putting off a decision until the June meeting (which may even get pushed into July). That way, OPEC+ officials will have more data on how U.S. sanctions are affecting production in Iran and Venezuela, and events surrounding the U.S.-China trade war will also become clearer.

However, the wait-and-see strategy carries risks. “The challenge though is that rather than being resolved, most of the uncertainties (both on the supply and demand side) will only intensify in coming months,” OIES warned.

Supply outages are already at multi-year highs of about 3 mb/d and could rise further. While OPEC+ can compensate for such a large volume of disrupted output, outages cloud the supply/demand picture and make it difficult to plan. In any event, if OPEC+ burns through spare capacity, that in of itself can drive up prices and volatility, even if every barrel knocked offline is accounted for. Related: Saudi Arabia Scrambles To Calm Oil Markets

However, the biggest source of uncertainty is on the demand side. The U.S.-China trade war threatens global growth at a time when economic indicators are not looking great. Ultimately, a downturn would drag down prices.

OIES lays out a few scenarios. If OPEC+ sticks with the cuts, Brent prices could rise by $5 per barrel in the second half of 2019 relative to the first half, topping $77 per barrel later this year. If they add supply back onto the market by eliminating “over-compliance,” Brent may stay at around $70. If they exit the agreement entirely prices could fall as low as $60.

Adding to the confusion, OIES included some pricing forecasts that incorporated an economic downturn. A gloomier economic outlook combined with an ill-timed exit from the OPEC+ agreement could send prices down to $50. 

Ultimately, OIES argues, there is a rather large gap in expectations between the bulls and bears. The bullish case rests on supply outages and OPEC+ sticking with its cuts, while a more bearish scenario sees turmoil within the OPEC+ coalition, forcing a premature exit from the deal. Adding to the downside risk is the possibility of an economic slowdown. The difference between these two outlooks is significant.

As such, the current state of low volatility, which hinges on assumptions about the steady hand of Riyadh, may not last.


“The extent of dislocations in expectations and the challenge of navigating in the current foggy conditions indicate that the oil market is set for a very bumpy ride,” OIES concluded.

By Nick Cunningham of Oilprice.com

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  • Mamdouh Salameh on May 23 2019 said:
    Between 2016 and 2017, US shale oil production tried to cap the Brent oil price at $60 a barrel. It failed miserably and $60 became the new price floor. US shale oil tried again in 2018 to cap oil prices at $70 but again failed and the $70 became the new price floor.

    Given the robust fundamentals of the global oil market and China’s unquenchable thirst for oil, the new price floor this year could be $80.

    If Saudi Arabia’s decision makers are rational, they will not repeat the mistake of last year when they succumbed to pressure from President Trump and raised oil production ending up with prices crashing by 43% in November last year and considerable damage to their economy.

    Indications from Saudi Arabia are that it will not raise its production thus abandoning the OPEC+ production cuts until the global oil market is irrevocably balanced. However, things could change were the US/Iran tension escalates into a shooting battle.

    On balance, a war between the United States and Iran is not an option for either of them.

    Iran is not seeking a war with the United States but it will retaliate if its crude oil exports were prevented from passing through the Strait of Hormuz. And while it will be virtually impossible to block the Strait completely, Iran can nevertheless mine it and wait for an oil tanker loaded with oil to hit a mine. That alone could deter oil tanker owners and insurance companies from sending their tankers across the Strait. Alternatively, Iran could threaten to sink an oil tanker. That could have the same effect like mining the Strait.

    President Trump has a far bigger war to worry about, namely the trade war with China. The trade war between the two superpowers is principally neither about oil nor about China’s trade surplus and alleged Chinese malpractices. It is about the petro-yuan undermining the supremacy of the petrodollar and by extension the US financial system, Taiwan, refusal by China to comply with US sanctions against Iran, the new order in the 21st century, China’s overwhelming dominance in the Asia-Pacific region and its sovereignty claim over 90% of the South China Sea and above all the fear of the US losing its unipolar status.

    Iran’s overall approach to its confrontation with the United States is based on the “war on oil doctrine”. It is a comprehensive war plan aiming to attack and disrupt the production and shipping of oil and gas in the Gulf region including blocking the Strait of Hormuz.The region’s States are aware of the Iranian designs and Tehran’s determination to implement them.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London

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