Last week West Texas Intermediate rallied 4.62 percent and was up for the second week in a row. It is important to note that the price trend is still clearly negative. Recent history suggests that WTI might form a consolidation band between $30-$40 (spending the most time between $30-$35) for 3-5 months before dropping again.
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Oil markets partially rose on the rumor of Russia and OPEC meeting to cut production, but the quickly-downplayed rumor wasn’t enough to lift WTI above a $34 close last Friday afternoon. In the presence of sluggish demand and a persisting supply glut, global oil markets are likely to face continuous downward price pressure from decreased demand and additional supply coming from two countries: Japan and Iran. Related: This Could Be A Big Setback For Iran’s Oil Export Plans
Japan
According to the EIA, Japan is the third-largest consumer of oil on the planet, consuming an estimated 4.3 million barrels of oil per day in 2014. Since virtually all oil consumed in Japan is imported, it is very telling about Japan’s recent relationship with oil that since 1997 imports have dropped from roughly 1.7 million to 1.2 million barrels per day:
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Most of Japan’s imported oil is consumed in the transportation (41 percent) and industrial (29 percent) sector. The decline in oil consumption and imports stems from structural factors, including a notable seasonally-adjusted decrease in industrial production of 3.5 percent from 2010 to December 2015. Another noticeable trend is that young Japanese drivers are driving less than previous generations and then there is a growing shift in the Japanese automobile fleet (which already had relatively strong fuel consumption standards (6.7L/100 km versus 5L/100 km in the EU) towards hybrid vehicles. Related: Russia Cries Dyadya (Uncle), Is Saudi Arabia Listening?
The downtrend in oil imports abated somewhat after the 2011 Great East Japan Earthquake and tsunami, with Japan’s oil consumption rising for the first time in almost two decades by 255,000 barrels a day in 2012 from 2011. This spike was short-lived, though, as by 2013 Japan had shifted towards LNG, coal and energy efficiency measures.
To put this in context, in 2013, LNG accounted for 43.2 percent of Japan's power generation, coal for 30.3 percent and 14.9 percent was produced from oil. Nuclear accounted for a mere 1.7 percent because just about all of the country’s reactors were shut down after the Fukushima meltdown. But the situation has changed since then. The government of Japan is now looking at nuclear power again in order to generate between 20-22 percent of its energy in 2030 (though still a far cry from the roughly 40 percent it generated pre-Fukushima). The return to nuclear is pushing down Japan’s consumption of competing fuels. Next to the decline in oil consumption, LNG consumption is also declining, recent numbers suggest a 3.9 percent LNG import drop from 2014 to 2015.
The downward pressure on oil and wavering LNG demand from the electric sector will likely continue as Japan has plans to gradually turn more and more reactors back online. In August and October of 2015 two reactors in the southern prefecture of Kagoshima operated by Kyushu Electric Power were restarted, ending the two-year moratorium on nuclear power generation. Kansai Electric Power’s No. 3 reactor at the Takahama nuclear plant in Fukui Prefecture, western Japan, reached criticality Saturday morning at 6 a.m., with plans to start loading the No. 4 reactor and restart it late next month.
When you combine Japan’s declining population, lower levels of industrial production, and government-mandated energy efficiency targets with the fuel shifts discussed, there is a very convincing argument to be made that the Japanese market will continue to be a decreasing consumer of petroleum products and will likely not provide consumption increases, nor price support, for oil or LNG.
Iran
On the supply side of the equation, Iran’s pledge to return to the pre-2012 sanction export levels of 4 million barrels a day by adding a million barrels of oil production is certainly going to exert further downwards pressure on prices. Iran could be producing between 3.3 and 2.9 million barrels a day now. Those estimating that Iran is producing on the lower end of the gamut of estimates also share the view that Iran will only be able to produce between 300,000-400,000 additional barrels per day.
Iran was producing 4 million barrels as recently as 2012. President Rouhani’s recent visit to Europe resulted in a commercial rapprochement. This suggests that soon the National Iranian Oil Company, to whatever degree, will be able to meet plant and human capital needs with imported oilfield equipment and expertise from Europe. Related: Is The Saudis Market Share Strategy Still Feasible?
With this development there is the chance that Iran will be able to produce a million additional barrels by the end of the year. Whether or not they do might depend more on economics and consensus from within its own ranks than technology and practice. It is also beneficial to remember the fact that Iran can sell oil that is currently in storage to claim market share in the near term while it improves its domestic output.
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As I wrote on OilPrice.com previously, Iran has an armada of “ghosted” oil tankers that are being used as storage facilities. Windward LLC, a firm that uses big data to track global oil production, estimated that Iran has about 47 million barrels floating in the Persian Gulf as of the end of January 2016. As the below bar graph shows, Iran might have more than 47 million barrels in the Gulf due to a greater capacity and the possibility of current storage underestimation.
In the mid-term, it looks like both Japan and Iran are likely to drive the oil markets further from an equilibrium situation. Even though the demand for oil products is up in the U.S. and cracks in worldwide crude supply are showing, it will still take at least a year for oil markets to start balancing out. I’ll leave the speculation about the price up to you.
By Hafad Zubi for Oilprice.com
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