The risk of oil supply disruptions from around the world has diminished, and rising non-OPEC production provides a “solid base from which to react to any escalation in geopolitical tension.”
In its January Oil Market Report, the International Energy Agency (IEA) said that there is plenty of oil sloshing around, despite the U.S. and Iran nearly going to war. “We cannot know how the geopolitical situation will play out over time, but for now the risk of a major threat to oil supplies appears to have receded,” the IEA said. “As was the case following the attacks on Saudi Arabia in September, once the initial fears of a sustained supply shock subsided, the Brent price rapidly gave up its $4/bbl spike.”
Oil inventories held in OECD countries is 9 million barrels above the five-year average, and there are also plenty of strategic stockpiles to call upon in the event of an outage, the agency said.
Still, while geopolitical risk has “faded,” it has not gone away entirely. The Trump administration may have refrained from all-out war against Iran, but the assassination of General Soleimani took the confrontation to new heights.
While Trump’s speech earlier this month was widely interpreted as one of “de-escalation,” he also prefaced his comments by saying Iran would never have a nuclear weapon. But, sanctions, “maximum pressure,” and the assassination of one of its top leaders will obviously provoke a response. With little left to lose, Tehran is backing out of most of its commitments under the 2015 nuclear agreement, a deal that the U.S. already exited nearly two years ago.
All of which is to say the countries are seemingly locked on a collision course. The world breathed a sigh of relief when the two countries backed away from the brink, but there are decent odds that the conflict flares up again in the not-so-distant future. There are few pathways for actual de-escalation, absent an overhaul of U.S. policy.
At the same time, Iran has already lost much of its oil supply due to sanctions. So, the additional supply risk is concentrated in Iraq, where the U.S. and Iran conflict is actually playing out. “Recent events have shown that Iraq is a potentially vulnerable supplier, just as its strategic importance has grown,” the IEA said. The agency noted that Iraqi oil exports have doubled since 2010, from 2 million barrels per day (mb/d) to 4 mb/d. China and India each import roughly 1 mb/d of supply from Iraq.
“Iraq’s rising capacity has been very welcome as sanctions have reduced Iran’s exports to only 0.3 mb/d and Venezuela’s production has collapsed,” the IEA wrote. Left unsaid was that those outages were both the result of U.S. sanctions.
Putting aside the geopolitical risk, the agency said that prices will likely remain subdued this year because non-OPEC supply continues to grow faster than demand. Non-OPEC countries will add 2.1 mb/d this year, while demand will rise by 1.2 mb/d.
Unlike in previous years, U.S. shale won’t dominate the supply growth picture, at least not entirely. The sector will likely see a “marked slowdown,” accounting for 52 percent of non-OPEC supply growth, down from an 84 percent average between 2017 and 2019. Instead, Norway, Brazil, Canada, Australia and Guyana will add new barrels.
The bottom line is that OPEC+ still faces a predicament. “Even if they adhere strictly to the cuts, there is still likely to be a strong build in inventories during the first half of 2020,” the IEA said. “OPEC crude production would fall to 29.3 mb/d in January if there were to be full compliance and steady output from Libya, Iran and Venezuela. That is still 700 kb/d above the 1Q20 call on OPEC crude and 900 kb/d above the 2Q20 call.”
In other words, unless OPEC+ cuts further, the oil market faces persistent oversupply in the first half of this year.