The oil market is “tightening up,” according to a new report from the International Energy Agency (IEA).
At first glance, the headline figures don’t look so bad. Global supply surpassed 100 million barrels per day (mb/d) in August, a new record high. Production even rose from OPEC, despite turmoil seen in several member countries.
But beneath that impressive supply figure, there are plenty of cracks that are all too familiar. The IEA acknowledged that oil prices experienced a dramatic swing since its last report in August, with Brent falling close to $70 before bouncing back up close to $80.
The reason for the volatility is the ongoing supply losses from Venezuela, combined with the disruptions in Iran related to U.S. sanctions. Venezuela’s production fell by another 40,000 bpd or so, taking output down to just 1.24 mb/d. The country is on track to end the year at 1 mb/d or lower. Meanwhile, buyers are already cutting their purchases of Iranian oil ahead of the November 4 deadline, resulting in the loss of some 500,000 bpd to date, with more declines expected.
Ultimately, the problems facing these two countries could push up oil prices. “If Venezuelan and Iranian exports do continue to fall, markets could tighten and oil prices could rise without offsetting production increases from elsewhere,” the IEA warned. There are some production increases elsewhere, including the combined 160,000 bpd from Saudi Arabia and Iraq over the past month. In fact, Saudi Arabia added 400,000 bpd since May and Iraq added 200,000-bpd over the same timeframe.
The IEA put total spare capacity at 2.7 mb/d, 60 percent of which is in Saudi Arabia. That is a larger buffer than some other analysts believe, although the IEA notes that just because the headline figure is 2.7 mb/d, that does not mean that all of that is available on short notice. “[T]he point about spare capacity is that, having been idle, it is not clear exactly how much, beyond what is widely thought to be ‘easy’ to bring online, will be available to coincide with further falls in Venezuelan exports and a maximisation of Iranian sanctions,” the IEA cautioned.
Adding to the complexity is the fact that overall crude output levels are one thing, but the ability of refiners to process the available production mix is another. At times, U.S. shale output is held up as an easy fix for production problems in OPEC countries. But the quality of the crude is very different. Refiners used to medium or heavy blends from some OPEC countries cannot simply swap in light crude from Texas. “It is not just a question of volume; refiners used to processing Venezuelan or Iranian crude will compete to find similar quality barrels to maintain optimal refinery operations. Alternative supplies of lighter crude might not be ideal for this reason,” the IEA said.
But leaving aside the dynamics of the downstream market, the upstream fundamentals still look rather tight. OECD inventories at the end of July were 50 million barrels below the five-year average, and in the U.S., crude stocks just fell below the 400-million-barrel mark for the first time since early 2015. Critics might point out that U.S. stocks are still within the “five-year average” range, but that range is now made up mostly of surplus years, which obscures its meaning.
So, if the market is tight, where might we get more supply? The IEA notes that Brazil was thought to be a major source of non-OPEC supply, but “various problems have stymied growth to the extent that output will rise by only 30 kb/d this year versus a first estimate of 260 kb/d.”
The U.S. remains one of the few sources of huge supply growth, even after taking into account the bottlenecks in the Permian. The IEA expects total liquids production to grow at an “extraordinary pace” this year, expanding by 1.7 mb/d, plus an additional 1.2 mb/d in 2019.
All told, global supply actually increased in August, despite the woes in Venezuela and Iran. However, it will be hard to replicate that success going forward. For one, the supply figures for last month were significantly higher than a month earlier due to the restoration of production in Libya after a major outage. Libya gained more than 250,000 bpd in August. But, the latest attack on the headquarters of the National Oil Company in Tripoli is a reminder that another outage could occur at any time.
Moreover, even if Libya can avoid disruptions, there is little chance of replicating the gains from last month. Other gains came from Nigeria and Iraq, and it is unclear if they can continue to add new supply.
That means that the ongoing losses from Iran and Venezuela will be hard to paper over in the coming months.
The one caveat to this tighter supply story is the demand side of the equation. The IEA left its demand growth figures unchanged but noted that it remains a downside risk to oil prices because there is growing evidence of a slowdown in various parts of the globe. Higher gasoline prices means demand is flat in the U.S., down in Europe compared to year-ago levels, and “sluggish” in Japan. More importantly, the currency trouble in emerging markets could translate into lower demand, and the U.S.-China trade war could yet upset the global economy.
Nevertheless, the supply losses from Venezuela and Iran remain the dominant story. “We are entering a very crucial period for the oil market. The situation in Venezuela could deteriorate even faster, strife could return to Libya and the 53 days to 4 November will reveal more decisions taken by countries and companies with respect to Iranian oil purchases,” the IEA concluded. “The price range for Brent of $70-$80/bbl in place since April could be tested. Things are tightening up.”