Goldman: The Oil Market Can Handle Iran Outages

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By Nick Cunningham

Oil prices cooled off in recent days as fears of an acute shortage of supply stemming from sanctions on Iran started to subside.

At least two companies in India have lined up oil shipments for November, the month that sanctions on Iran take effect. The 9 million barrels of oil secured for next month translate into nearly 300,000 bpd of supply. Meanwhile, other reports suggest that the U.S. is softening its zero tolerance approach to sanctions, and could issue waivers to some importers who make significant reductions but struggle to cut imports to zero. Taken together, the oil market is not nearly as concerned about a supply shortfall as it was as recently as last week.

In fact, the precise amount of Iranian supply lost to sanctions could determine quite a bit. “If the declines in Iran exports are sooner and larger than our base case, it will be harder for other producers to offset them,” Goldman Sachs wrote in a note last week. The uncertainty lies with the exact amount of supply lost from Iran, and the uncertainty over whether or not there is enough spare capacity to compensate.

However, if Iranian supply declines by less than expected, then there is much more downside risk for oil prices, especially since there are other reasons to be a lot less worried about a supply crunch. “While upside price risks will prevail for now, fundamental data outside of Iran has not turned bullish in our view,” Goldman wrote, citing the surge in Saudi production over the last few months, which increased global inventories counter-seasonally. In other words, the market is heading into a softer demand season with larger stockpiles than otherwise would have been the case, offering some buffer in the event of a supply deficit.

Also, some of the oil producers that have typically accounted for unexpected outages – namely, Libya and Nigeria – have actually restored output and have (so far) sustained those gains. Libya’s production is reportedly up to as high as 1.25 million barrels per day. “Our current production is 1.25 million barrels (per day). We have ambitions to increase it further,” Mustafa Sanalla, CEO of the National Oil Corporation of Libya, told reporters on the sidelines of the Russian Energy Week.

Taken together, Libya and Nigeria are producing 0.3 mb/d more than expected, Goldman Sachs estimates, which offsets a portion of the losses in Iran. Iraq too could add more supply. These production gains are always tenuous, but for now they are holding up.

The futures curve also offers a bit of evidence to suggest that the market is not extraordinarily tight. Timespreads in the Atlantic basin have been declining, which “suggests local oversupply,” not tightness, Goldman wrote.

If the market can make it through the next few months, and Iranian supply does not fall as far as some fear, then we will transition into a softer period. For one, demand slows in winter months. But supply is also expected to pick up. U.S. shale will continue to add production, although at a slower rate. Spare capacity will also come back a bit, Goldman says.

These arguments are all subject to what happens with the timing and the magnitude of the outages in Iran. “The two key uncertainties the oil market has to grapple with are first the spare capacity to replace Iranian barrels and, second, the unknown magnitude of these lost volumes due to a lack of clarity from the U.S. administration,” Goldman analysts wrote in their report. “Our base case remains for a loss of 1.5 million b/d (4Q18 vs. 2Q18)…Through end-September, 0.7 mb/d of Iran exports have been lost, compensated by higher production levels from other OPEC+ members.”

The next wave of losses could push the market into a deficit, perhaps as high as 0.4 mb/d. That isn’t a necessarily a disaster because of the counter-seasonal build in inventories over the last few months, Goldman argues. As long as everything else holds up and there are not additional outages, prices may remain subdued. “It’s all a matter of timing,” Goldman concluded.

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