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Tsvetana Paraskova

Tsvetana Paraskova

Tsvetana is a writer for the U.S.-based Divergente LLC consulting firm with over a decade of experience writing for news outlets such as iNVEZZ and…

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All-Time Low Spare Capacity Could Send Oil To $150

markets

While the oil market and analysts are trying to guesstimate how much Iranian oil the U.S. sanctions will stifle later this year, they all agree that the return of the sanctions is the market’s key bullish driver as well as the largest ‘known unknown’ for oil prices later this year and into 2019.

Some ultra-bullish hedge funds think that the U.S. sanctions will remove much more than 1 million bpd of Iranian oil from the market. Considering the low spare capacity for a quick ramp-up of production elsewhere, some hedge fund managers expect oil prices to jump to as high as $150 a barrel in 18 to 24 months.

“Our view is that by November 4, we will have lost between 1.3 and 1.4 million barrels [of output] a day. It is a very big number. That’s based on the view that the U.S. will allow a few temporary exception waivers,” Jean-Louis Le Mee, CEO at London-based Westbeck hedge fund told Reuters. “Ultimately, we could see losses from Iran exceed 2 million barrels a day,” Le Mee said.

According to Pierre Andurand, who manages the US$1.2-billion Andurand Commodities Fund, the world’s spare capacity is at its lowest ever, and this will be a real issue with global oil supply.

Replying to one of President Trump’s tweets blaming OPEC for the “too high” oil prices, Andurand said in mid-June that “OPEC has the lowest spare capacity ever right now. There is going to be a real issue. Prices will be above $150 in less than 2 years. Eventually higher prices will bring more supply. But right now too little supply coming over the next few years despite US supply growth.”

Generalist investors don’t have such bullish views, but “this is going to catch everybody by surprise,” Westbeck’s chief investment officer Will Smith told Reuters.

“If we are right about oil going from $75 to $150 over the next 12 to 18 months, out-of-the-money oil options, further down the curve ... look very exciting. The pay back there is just fantastic if we are right,” Smith said.

The loss of 2 million bpd of Iranian oil is the assumption in the hedge fund’s bet on $150 oil in a year or two. Iran’s oil exports peaked in April this year at 2.7 million bpd, and have been dropping every month since then. Related: Oil Prices Fall On Significant Crude Build

Analysts expect Iranian oil exports to drop more noticeably beginning this month and in September, and the rate of decline to accelerate as the United States looks to have Iran’s current customers reduce Iranian oil imports to ‘zero’.

According to Bank of America Merrill Lynch, total cut-off of Iranian exports would lead to a price spike to above $120 a barrel. But, BofA noted in July, the U.S. might be able to take around 500,000 bpd of Iran’s oil from the market.

Yet, the U.S. Administration’s efforts to persuade as many countries as possible to drop imports of Iranian oil have intensified over the past month, and many analysts now see 1 million bpd as the more realistic assessment, up from initial estimates of some 500,000 bpd.

One of the bullish analysts, Energy Aspects, sees the sanctions removing 1.2 million bpd-1.5 million bpd of Iranian oil from the market, chief oil analyst Amrita Sen told CNBC last week.

“As we go more towards (the fourth quarter) … that’s when we really see the risk of prices going well into the 80s and potentially even into the 90s but very critical is how much Iranian production we lose,” Sen said, adding that 1.5 million bpd could be a “conservative” estimate for Iranian export losses. Related: LNG: China’s Biggest Weapon In The Trade War

Earlier this month, BofA said that although trade wars are a major downside risk to oil demand, it remains “much more concerned” about the sanctions on Iran. “For every 1 million barrels per day imbalance, we see a price impact on Brent of around $17,” Bank of America said.

Yet, the generalist investors in Brent Crude options are not following or sharing the views of the most bullish hedge funds, and their largest increase in open interest in Brent options over the past month has been in put options, or contracts to sell oil at $60 to $65 a barrel between October 2018 and December 2020, according to estimates from the Intercontinental Exchange compiled by Reuters’ Amanda Cooper.

Investors and analysts who don’t see oil prices spiking to triple digits on the sanctions against Iran have reasons for being bearish, too. Escalating trade wars could dampen global economic growth and consequently, oil demand growth. The strengthening U.S. dollar both raises the oil-importing countries’ import bills and makes dollar-priced oil more expensive to buy for holders of other currencies. Then there are also concerns that oil above $80 is the start of demand destruction, which OPEC and its Russia-led friends want to avoid.

For now, just a couple of super bulls bet on oil prices returning to record highs, but we have yet to see what the biggest ‘known unknown’—how many Iranian barrels will actually be off the market—has in store for the market later this year.

By Tsvetana Paraskova for Oilprice.com

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  • petergrt on August 15 2018 said:
    So the assumption is that the current price is based upon a perfect balance between supply and demand . . . . .?!

    Russia bases its economic projections on a $40 oil, while it is now effectively at $80, when taking into account the recent strength of USD . . . .

    Furthermore, the oil demand growth numbers are beginning to be revised downworth, and the effect of the strong USD hasn't even begone to show up, albeit industrial metals as copper have been tanking - not a good sign for the world economy and the resultant demand for oil.

    China is switching from the US oil to Iranian crude.

    These are but a few of many more factors that I believe will cause the oil to continue its downword 'correction' at least until the end of the year.
  • semos Gardner on August 16 2018 said:
    another ridiculous bull article.. while oil drops its pants and shows its truck mud
  • Mamdouh G Salameh on August 16 2018 said:
    Hedge funds, investment banks and many analysts and experts are burying their heads in the sand and ignoring the realities in the global oil market by continuing to hype about the impact of US sanctions on Iran’s oil exports either out of ignorance of the prevailing fundamentals of the global economy or currying favour with the Trump administration.

    And I keep telling them that US sanctions against Iran are doomed to fail and Iran will not lose a single barrel of oil from its oil exports as a result of the sanctions.

    My reasoning is based on five market realities. The first is that the overwhelming majority of nations of the world including US allies and major buyers of Iranian crude are against the principle of sanctions on Iran as unfair and will not therefore comply with them and will continue to buy Iranian crude whether in violation of the sanctions or by a US waiver as would be the case with Japan, South Korea and Taiwan.

    The second is the petro-yuan which has virtually nullified the effectiveness of US sanctions and provided an alternative way to bypass the sanctions and petrodollar.

    A third reality is that China which is being subjected to intrusive US tariffs and Russia which has been battling US sanctions since 2014 will ensure the failure of US sanctions against Iran as a sort of retaliation against US tariffs and sanctions against them.

    A fourth reality is that China can singlehanded neutralize US sanctions by deciding to buy the entire Iranian oil exports amounting to 2.5 million barrels of oil a day (mbd) as a retaliation against escalating US trade war against it and paying for them in petrodollar.

    A fifth reality is that 95% of Iran’s oil exports go to countries who declared that they will not comply by US sanctions, namely China (35%), India (33%), the European Union (20%) and Turkey (7%). The remaining 5% of Iran’s oil exports goes to South Korea and Japan who have already said they will apply for a US waiver and most probably they will get.

    As for global spare production capacity, it ranges between 2-3 mbd of which Saudi Arabia claims to have 2 mbd. However, the Saudi spare capacity is not one resulting from Saudi ability to ramp up production by 2 mbd above current levels but is merely dipping into its stored oil on tankers and on land. Once the stored oil is depleted, there will be no capacity whatsoever.

    The world could face an oil supply gap by 2020. There will be a need for 15 mbd of new oil to meet growing global ol demand and to offset an annual depletion rate estimated at 5% or 4.8 mbd, equivalent to the oil production of Iraq.

    Failing to provide new supplies of oil by 2020 could lead to oil prices surging far beyond $100 a barre.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London
  • Alex on August 16 2018 said:
    About 2 years ago, when oil was around 36-40, somebody in coments said the oil soon will be 70. How he knew it?
  • Sean Yun on August 16 2018 said:
    I do not think so, however the oil price, based on benchmark WTI , will be stably moving in the range of 70-80$ until the end of Trump Goverment, maybe six more years?

    The reasons are like below:

    1. If the oil price go over 80$ range, it is a sort of signal that world economy starts recession. Because as you may know that the Fed has been hiking its rate since 2015, and next month we will have one more rate-hiking in Sep, also there will be another raising rate in Dec. Also, in 2019, there will be 3-4 more times of rate-hiking by the Fed, and 2-3 times more in 2020yr. That means the market liquidity will be dwindled further and further, so no impetus to push up the oil price.

    2. Currently, the US$ has been stronger and stronger, as I had left a comment here, due to stronger US$ will block the oil price direction toward North, but South. That time, the US$ index was hovering around 93level, however today at this moment, it is moving in the range of 96.46. That means US$ has been more and more expensive since last 2nd economic quarter. As you can see that the WTI has been moving down and down.

    3, Now, so called EM ( Emerging Market) has been suffering from financial instability due to the above 1, 2 reasons. Thus, EM's economies are getting slower and slower than ever since 2013yr. For example, Chinese have not yet imported any barrels from the USA in Aug. As you know that Chinese currency Yuan has been depreciated against US$ more than 6% since June.

    Based on the economic conditions above, the oil price cannot go up to the level of even 80$, however, US Government does not like strong US$ compared to EM currencies esp against Asian currencies as President Trump talked about it in May. Soon or later, the US$ direction will be turned to devaluation against esp Asian currencies in connection with 10yr US treasury's moving toward over 3.0%, currently at 2.86%.
  • Clyde Boyd on August 16 2018 said:
    One good thing about OilPrice.com is that one story will say oil will go to $150/barrel and the next story will say oil is going down to $30! There is no consistency or rationale. Inother words there is something for everyone.

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