Geopolitically things haven’t materially improved since tensions between the U.S. and Iran escalated early in the second quarter of the current oil trading year. If anything, it can be argued that Iran’s recent seizure of British flagged Swedish-owned oil tanker Stena Impero, swiftly followed the U.S. deployment of its aircraft carrier USS Abraham Lincoln, its Carrier Strike Group 12 and U.K. warships have ratcheted things up a notch.
Yet, the oil price refuses to fire up courtesy demand concerns, largely as Washington and Beijing face-off in a trade war that threatens to get a whole lot worse before it gets better. It is not the only bearish factor on the horizon, with serious concerns over the global economy.
Such concerns have prompted the International Energy Agency (IEA) to lower its global oil demand growth forecasts for 2019 and 2020 to 1.1 million and 1.3 million barrels per day (bpd), respectively. Many analysts, myself included, have been accused of complacency and giving too much weight to demand concerns and not paying enough attention to supply concerns.
I dispute that. Quite the contrary, a supply-side examination in step with a demand-side observation lead me to opine that the oil market will see a continued, sustained lower price environment. I am neither predicting a collapse nor a spike, and unlike many others, I am not overtly focused on an uptick in U.S. production.
While rising, I do not expect U.S. production to cap 13 million bpd this year. But the country will remain the world’s largest producer by some distance. Other gains are following from Norway, Brazil and Guyana.
Curiously, Iranian exports while falling are not down to zero and will be never be so, because Tehran is an expert at exporting in the shadow of sanctions. Given Washington and Beijing are trading economic salvos, few expect China to be compliant at unilateral U.S. sanctions on Iranian oil.
Not only will China maintain channels open to Iran but perhaps extract a headline discount too. Curiously, the IEA cited China as the only major source of oil demand growth; at 500,000 bpd for the first half of this year.
Sidestepping who is exporting what volume, the oil and gas sector is fast getting used to doing more with less. Anecdotal and empirical evidence has consistently pointed to this over the last half decade, more so since 2016.
If you looked at oilfield services (OFS) firms’ recent order books, you’ll find many players – major and minor – with flat to down order backlog filings. The industry is not poking more holes in the ground, its learning to optimize what it operates. It is also drilling a lower number of wells and is getting rather efficient at that too.
BP’s latest financials offer a case in point. Fresh from its acquisition of BHP’s U.S. shale assets, which it began operating on March 1, the oil major says its latest exploration forays are resulting in 15% more efficiency out of wells, drilled at 50% lower cost, in its medium-term march to a $30 breakeven. BP is not alone; rivals are also reporting similar efficiency initiatives give or take a few percentage points.
Of course, the biggest bearish trade war related factor could become a bullish one were the cloud of a full-blown U.S.-China tiff be lifted, but the price ceiling is unlikely to go much further than $70 using Brent as a benchmark, and 2019 will most likely result in an average price of ~$65 per barrel.
All the while, OPEC remains in a spot of bother. After the Brent front-month contract slid below $60 last week, Saudi Oil Minister Khalid Al-Falih said he would work with partners and “do whatever it takes” to stabilize the oil market.
Only problem is, Saudi Arabia and its OPEC and non-OPEC partners are already cutting production to the tune of 1.3 million bpd to 2020, and are still being buffeted by macroeconomic headwinds. So assuming the “do whatever it takes” quip implies further cuts from the cartel, I believe a token move would provide little more than a temporary uplift to the oil price.
While oil market is tightening, the IEA forecasts robust non-OPEC production growth in 2020 at 2.2 million bpd from the very production sources I have outlined above. Square that against OPEC and non-OPEC cuts, and there’s nothing to prevent the market from remaining in surplus.
To me, “whatever it takes” would imply OPEC+ increasing its production cuts level by 1 million bpd to 2.3 million bpd. That would be extremely draconian and doubtful but also one of its few remaining options to create a short-term jump in the oil price.