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Global Energy Advisory 12th July 2019

Today’s IEA report isn’t exactly a speculator’s dream forecast. 

Previously, the IEA was predicting a crude supply deficit of a half a million barrels per day next year. Not anymore. Friday’s report projects that supply will actually dwarf demand by nearly a million barrels per day. And in the first half of this year.

That’s a significant overhang.

And it could get even worse. Non-OPEC producers are set to unleash an additional 2.4 million bpd of crude into the market next year. That tally made possible by new North American pipeline capacity and production expansion in Norway, Brazil and Australia. 

Welcome to the new oil market. It’s far less sensitive to OPEC’s production quotas. 

The Hormuz Fear Factor

Watch oil shipping insurance prices skyrocket now--and they were already doubled for the war risk. The problem is that this risk premium hasn’t been priced in yet, and the showdown of tankers in global shipping lanes is just beginning …

This is a game of cat and mouse. Whether Iranian boats attempted to “impede”, “harass” or “seize” a British oil tanker in the Strait of Hormuz Wednesday is all the same game. The British Heritage vessel, chartered by BP, knew it was coming, which was why they were hunkering down off the Saudi coast prior to that, afraid to move on. The Iranians weren’t daunted by the ship’s military escort, either. The Iranians can play cat and mouse quite well. The question is, what is the UK’s game?

The UK seized a tanker carrying Iranian crude near Gibraltar last week--on orders from Washington. This is where Europe is divided and conquered. London, isolated in its Brexit drama, is keen to show the Trump administration that it’s the best Western ally in Middle East operations. By going through with the Gibraltar order, the UK has put the final nail in the coffin of INSTEX--the European system that was supposed to be a financial workaround for Iran on US sanctions. This move pits Iran and against the UK (a supporter of the 2015 nuclear deal with Iran, ostensibly), but also pits the UK against Spain, which was the one who leaked the intelligence that the Gibraltar vessel detainment was on Washington’s orders. The diplomatic chaos here extends far and wide.

We don’t need actual violence in the Strait of Hormuz to close off shipping lanes. Fear alone will do the trick.

We’ve seen insurance costs for transiting the Strait of Hormuz increase 20 times since the last attack on a vessel, and they’ve increased ten-fold in just two months. Beyond that, Western tankers are now taking on pricey military escorts in order, fearful of reprisal from Iran over the detainment last week of a vessel carrying Iranian crude near Gibraltar.

Everything is now a high-risk endeavor--the Strait of Hormuz, the Gulf of Oman, the Suez Canal, the Persian Gulf, the Gulf of Aden … This is where the war-risk premium comes into play, and it will be highest near the Strait of Hormuz choke point, in the Middle East Gulf and the Gulf of Oman. The 21-mile wide Strait of Hormuz is the key maritime transit route for Persian Gulf oil exporters. The EIA estimates 18.5 million b/d of seaborne oil exports passed through the Strait in 2016, mainly to customers in Asia. And there are few alternatives.

The lack of alternatives to sailing is risky waters has caused, as of this month, shipowners to pay up to 0.4% of the value of the cargo just in insurance. That’s double what they were paying a couple of months ago. And the risk is about to get worse.

Despite the increased costs of shipping oil through the risky shipping lanes in the Middle East, the increase has not trickled down to the price of crude, which has failed to increase in any meaningful way--yet. In fact, OPEC members have actually reduced their OSPs, with Saudi Arabia reducing prices to its prime market, Asia, by as much as $0.55 per barrel for August.

That the risk premium hasn’t been priced yet into the market is worrisome, if only because at some date in the future, the higher cost borne by the shippers today will inevitably need to be passed on to the buyers, even without an actual disruption in the world’s most critical oil chokepoint.

Where the Money Is: European Battery Manufacturing

Watch Europe’s battery hunger take on new proportions as it tries to beat China to the punch. The European EV market was up 28% in May over the same last year, with a whopping 37,000 new registrations in that month alone. Now the Union is going to have to shift manufacturing to EVs, and to do that they’ll also need to be able to produce batteries. For anyone investing in this space, this is the time to watch for potential deals with the EU for manufacturers and anything linked to this supply chain.

Right now, all the batteries powering Europe’s growing fleet of electric cars are coming from Asia, and mostly from China. Look for EU moves to entice investors here--to the tune of billions of dollars. The European Investment Bank is also all over this, having approved (preliminarily) a $390-million loan for NorthVolt AB’s battery gigafactory plan in Sweden, among other things. The medium-term game here is to control over 10% of the global battery cell manufacturing market by 2025. The long-term goal is not to need China at all.  

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