As a major net oil importer, US foreign policy has traditionally reflected the need to protect extended international oil supply chains. Over the last decade, even over the last five years, the country’s oil import/export profile has changed dramatically; net imports of crude oil and products have fallen from 5.6 million b/d in July 2014 to 1.6 million b/d in July 2019.
Now far less dependent on energy imports, the fear was that the US would withdraw from its reduced international interests, leaving power vacuums in its wake. This did occur to some extent, but the oil market is now more dominated by US policy decisions than ever as Washington prosecutes a trade war with China and takes a hard line on Iran.
Part of the reason for this dominance is that US gross imports of crude oil and products have barely changed in volume over the last five years, while rising LNG exports provide another point of US entry into world energy markets. The US has not become so much ‘energy independent’ as more involved in international energy trade, albeit on a more balanced basis.
The growing exposure of the domestic US economy to international trade, of which energy is one element, is a key concern currently expressed by the more dovish members of the Federal Reserve’s Open Market Committee. The flipside is that the oil market equally is now more exposed to the politics of US presidential elections.
The latest assessment by maritime consultants Drewry shows its global container port throughput index rising 1.1% in May year on year. The index covers 220 ports worldwide, representing 75% of global volumes. Drewry attributed the tepid expansion to a slowdown in global economic growth and tariff war issues, which, it said, were having “a marked effect” on container trade.
The US showed the largest annual increase, but even here expectations have grown that the US Federal Reserve will today (Wednesday, July 31) cut its federal funds rate by 25 basis points and possibly signal the potential for further incremental reductions.
Such a move should prove supportive for the oil market, but it is far from clear that a downward cycle in interest rates will be initiated. Indicators for the domestic US economy remain relatively robust, particularly employment, with the downside risks largely concentrated on the potential impact of a weak international trade environment.
Based on the Fed’s core targets – the promotion of maximum employment, stable prices and moderate long-term interest rates – the case for interest rate cuts is far from compelling.
Alongside the Fed’s deliberations this week are the resumption of US-China trade talks in Shanghai amid some positive signals but equally modest expectations of a breakthrough on fundamental issues. The G20 meeting in June produced a truce rather than a reversal in the trade war, but has at least prevented the imposition of further tariffs for the moment and seen the resumption of some Chinese buying of US agricultural products.
US President Donald Trump has provided mixed signals, but appears to be taking a relatively hard line, viewing two possible outcomes; major Chinese concessions which allow the declaration of a clear US victory, or a lengthy battle until after the November 2020 US presidential elections. In this scenario, not ‘selling out’ to China becomes a major campaign issue with a more balanced agreement possible only after a second presidential term has been secured.
Supply and demand
For the oil market, the likelihood is continued moderation in expectations for global oil demand. In its July Short-Term Energy Outlook, the US Energy Information Administration downgraded its oil demand forecast for 2019 by 200,000 b/d to 1.1 million b/d. It expects global oil inventories to rise by 100,000 b/d through 2019 and 2020, as non-OPEC output gains outweigh OPEC+’s decision at the end of June to extend production curbs for a further nine months through to end-March 2020.
OPEC’s compliance rate was notably down in June, at 104%, compared with 117% in May, according to secondary sources. Weaker compliance from Saudi Arabia can be expected as direct crude burn for power generation rises to meet summer cooling requirements, while Iran’s output has to be differentiated from exports as sanctions force more of the country’s crude into storage. As with the last period of sanctions, Iranian domestic use of crude oil and high sulphur heavy fuel oil for power generation is also likely to be high.
In the absence of a pick-up in the global economy, this creates a clear divide between downside risk, attached to international trade, and upside risk which exists primarily in the political and geopolitical spheres.
The Libyan civil war could at any time move to centre ground, with the country’s National Oil Corporation warning that about 700,000 b/d of production could be affected.
However, Gulf tensions surrounding US sanctions on Iran remain the primary source of oil market support and volatility. Attacks on tankers, drone shootings, Iran’s breaking of the terms of its nuclear agreement with regard to uranium enrichment and, most recently, retaliatory tanker seizures have all ratcheted up tensions between the antagonists. Yet all have stopped short at critical moments, recognising escalation to more direct conflict would have highly unpredictable outcomes.
This has produced a tenuous balance in the Gulf and in the oil market, with Brent trading for the most part above $60/b and WTI above $55/b, a level sufficient to sustain US crude oil production growth for the moment. This the EIA sees rising from 11.0 million b/d in 2018 to 12.4 million b/d this year and 13.3 million b/d in 2020.
This will be backed by other non-OPEC supply in 2020 from Norway, Canada, Brazil, Guyana and others of around 1 million b/d combined.
The difference is that while this output might be subject to project delays, it is relatively certain long-cycle investment which will not be affected by a weaker price environment than that forecast by the EIA, which puts Brent at an average $67/b for the remainder of 2019 and 2020 and WTI at $62/b and $63/b respectively.
In the absence of heightened Gulf tensions, or as oil traders downgrade the risk attributed to flashpoint incidents in the Gulf based on recent experience (rightly or wrongly), and with no major reduction in Libyan output, Brent and WTI could prove weaker than in the EIA’s current forecast scenario, prompting a supply-side slowdown in the more price-responsive US shale plays heading into 2020.