World risks a full-blown oil shock within months as 3 geostrategic crises come to the boil
'We are pretty confident that oil will be in triple digits by next year'
The world risks a full-blown oil shock within months as three geostrategic crises come to the boil and Saudi Arabia hints at US$100 crude, setting off a speculative scramble by commodity hedge funds.
Brent crude has surged this week to a 40-month high of almost US$75 a barrel even though the global economy is losing momentum. This price spike is different from earlier China-driven episodes over the past 15 years. It reflects a constriction of supply and a rising "political premium." Such a context makes it more threatening.
We are pretty confident that oil will be in triple digits by next year
It is now highly likely that Donald Trump will reinstate oil sanctions against Iran on May 12, this time adding extra curbs on distillates. Japan and South Korea will almost certainly join the Americans. Most European firms will fall into line whatever the policy of their own governments since it is dangerous to defy the U.S. Treasury. Most insurers and shippers will steer clear of Iranian cargoes.
"We are pretty confident that oil will be in triple digits by next year," said Jean-Louis Le Mee from Westbeck Capital. By then the oil market will be feeling the delayed effects of a 40 per cent slump in investment from late 2014 to early 2017, storing up a structural shortfall of 8 million barrels a day (b/d).
Le Mee said the Iranian sanctions alone will take up to 500,000 b/d off the global market by the fourth quarter, rising to 700,000 in 2019.
This is happening just as the proxy-war between Saudi Arabia and Iran over Yemen reaches a lethal crescendo.
Escalating missile attacks on Saudi targets by the Iranian-backed Houthis threaten to detonate an epic clash between the rival Sunni and Shia alliance systems.
"The Houthis are not backing off. My fear for contagion is that one of these missiles will get through Saudi air defences and then we will be in a Mid-East war," said Helima Croft from RBC Capital. "If a Saudi tanker is sunk with 2 million barrels of oil, people are going to start worrying about the security of the sea lanes. Markets have been far too complacent," she said.
It is also happening as Venezuela's oil industry goes into near-terminal collapse, with drilling parts running out and thousands of long-suffering staff at the state energy group PDVSA walking off the job in protest over pay arrears. Output has crashed by 550,000 b/d since early 2017.
There is a clear risk that Washington will impose tighter curbs on the Maduro regime after the elections on May 20. "We would end the year down another 1m b/d if the crisis metastasises," said Ms Croft.
The OPEC-Russia cartel can at last declare "mission accomplished" though it has taken much longer than they ever imagined. Joint cuts of 1.8 million b/d have reduced OECD oil inventories towards their five-year average and cleared most of the global glut, with the Saudis cutting even deeper than agreed in an attempt to lift prices well above US$80 before selling off shares in Aramco.
Saudi Arabia and Russia are now signalling that they aim to extend the cuts deep into 2019. This has been the green light for hedge funds and ETF commodity investors. Ole Hansen from Saxo Bank said the speculative rush has pushed "long" commodity contracts to a five-year high of US$1.09 trillion.
The oil surge has pushed U.S. petrol prices to US$3 a gallon, prompting Trump to tweet in an unexpected outburst last Friday that OPEC is keeping prices "artificially very high."
U.S. shale output can no longer keep up with the global shortfall. Although U.S. production has rocketed by 800,000 b/d this year to a modern-era high of 10.5 million b/d in April, a lack of pipelines is increasingly leaving "stranded barrels" in the Permian basin of east Texas. The new infrastructure will not be in place until mid-2019. The logjams are even worse in Canada.
America's refineries are geared to mixing sulphurous imports from Venezuela. They cannot cope with the volume of quality "super-light" grades from shale. This chronic mismatch will remain until new refineries are built.
Strictly speaking, Trump's criticism of OPEC is correct. Bjarne Schieldrop from SEB says prices would slide to the low US$50s without the cartel cuts.
Nikolaos Panigirtzoglou from JP Morgan says global consumers enjoyed a US$1.8 trillion annual windfall — worth 2.2 per cent of global GDP — when oil prices crashed. This acted as a "tax cut" stimulus. The process is now going into reverse. Consumers have seen an US$800 billion squeeze. On cue, JP Morgan's instant "Nowcast" tracker of world growth has dropped from 4 per cent to 3.2 per cent since the start of the year, far below estimates of the International Monetary Fund.
It is hard to separate cause and effect. China has been cooling as credit curbs bite. Monetary tightening by the US Federal Reserve is lifting global borrowing costs. The slowdown may prove to be nothing more than a soft patch but late-cycle pathologies abound and there are reasons for caution. The rest of the commodity nexus has yet to show much sign of life. Metals have been lacklustre after stripping out price spikes in both aluminium and nickel, caused by US sanctions against Russia.
In the end, OPEC and Russia are walking a tightrope. They risk a serious misjudgment if they push prices too high. "It was US$100 oil from 2011 to 2014 that kicked off the renewable revolution that we have seen," said Hansen from Saxo. A return to US$100 oil would accelerate investment in electric vehicles and bring forward the moment of cost parity with petrol and diesel engines, at which point the oil industry risks losing its footing forever and going into run-off.
Whatever happened to those Saudi counsellors sagely warning last year that any sustained move above US$60 was short-sighted folly.
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