The oil market should be mostly balanced this year, although “policy risk” will be a much larger driver for oil prices than the underlying fundamentals, according to a new report from Standard Chartered.
Brent crude started the year off repairing the damage from the epic meltdown in the fourth quarter, but over the last few weeks oil prices have rebounded. Standard Chartered sees Brent rising much farther, averaging as high as $74 per barrel this year, before averaging as high as $83 per barrel in 2020.
However, this forecast hinges on a variety of key policy decisions. First, OPEC+ must keep its production cuts in place, and indeed the group needs to cap output at January levels. If they can manage that, then global crude inventories would only rise by a minor 0.1 million barrels per day (mb/d), according to Standard Chartered.
That would set the stage for a better situation for OPEC+ next year. “With non-OPEC growth expected to be limited outside North America, and U.S. oil supply expected to slow markedly, we think OPEC will be able to raise output by 0.5 million barrels per day (mb/d) in 2020 without unbalancing the market,” Emily Ashford and Paul Horsnell wrote in a Standard Chartered report
Although the supply/demand fundamentals appear to be “benign” in the face of OPEC+ market management, additional “policy risk” could have an outsized impact on prices.
Standard Chartered singled out the U.S. government as a major source of volatility. “If the balances were the sole driver of OPEC output policy, the stage would have been set for a relatively quiet year,” the investment bank wrote. “However, there is a disruptive factor in the market which is likely to complicate policy choices; U.S. policy has become harder to predict.”
After a quiet first year from President Trump, 2018 was markedly different. “13 market-moving tweets on oil expressing a strong desire for lower prices, significant developments in policy towards Iran and Venezuela, and a sense that domestic energy policy is in a period of substantial flux,” Standard Chartered wrote. “We think that the oil market, oil producers and oil analysts have yet to adapt fully to the uncertainty and policy risks injected into the oil market by the Trump presidency.”
There is very little clarity on how much oil will be lost in Venezuela and Iran, for instance, and the White House has a great deal of influence over these issues. As of now, the U.S. is squeezing Venezuela as hard as it can, effectively barring both the import of Venezuelan oil and the export of U.S. diluents to the country. That puts much of Venezuela’s oil production at risk.
Reports of idling tankers off both the coast of Venezuela and in the U.S. Gulf Coast attest to the disruption that is already underway. To be sure, the New York Times reported that Russia is sending some fuel shipments to Venezuela to help PDVSA process its heavy crude, which could help prevent catastrophic losses. However, the declines are expected to continue. The question is by how much?
As for Iran, the U.S. has clearly expressed its desire to take a harder line. By all accounts, the government plans on issuing no new waivers for sanctions, with the stated goal of getting Iran’s oil exports to zero. At around 1 mb/d currently, achieving that goal would amount be a major loss of supply.
The problem is that Trump’s goal of regime change in Venezuela conflicts with its Iran policy. Simply put, it is going to be tough to shut in output in both countries without sending crude oil prices significantly higher. If anything is certain when it comes to Trump’s whims and desires, it is that he wants low gasoline prices. It’s not clear how he achieves that while simultaneously encircling and shutting down the oil industries in both Venezuela and Iran. Beyond Venezuela and Iran, another source of great uncertainty is the global economy. The U.S.-China trade war may be on hold, but the deadline for a deal is only a few weeks away. A ratcheting up of tensions could kneecap the global economy – and it’s a decision that is entirely up to Trump.
It isn’t just Trump, however. Another layer of uncertainty will come from the implementation of regulations on marine fuels by the International Maritime Organization (IMO). The sulfur concentration in marine fuels will have to drop from 3.5 percent to just 0.5 percent by January 2020, which could cause some upheaval in refined fuel markets. Indeed, the margins for gasoline and diesel have already diverged significantly.
This a rather long list of major policy decisions and endeavors that complicate any pricing forecast, and in fact, they question the very utility of trying to predict oil prices in this environment.
As Standard Chartered noted, if we simply extrapolate forward OPEC+ cuts we can come to the conclusion that inventories would be mostly balanced, resulting in “a quiet year” for oil.
However, even as OPEC+ commands enormous influence over crude prices, the oil market is at the mercy of a handful of policy decisions, many of which will be made by the U.S. government.