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Oil: Bull Case Limited in Near Term, OPEC Scaremongering Infinite

Published 13/10/2023, 07:59 pm
  • New China data brings back old worry about economy in top oil importer
  • 2024 oil demand likely lower than thought, says IEA, disputing OPEC’s outlook
  • Iran sanctions enforcement likely tough on words only
  • Record US oil production, exports that defy story of falling rigs
  • At a journalism clinic I hosted in Asia some years back, one of my pleas was “don’t throw the entire kitchen sink at the story”.

    A good point or two is often enough to make your case, I said, though I did raise the caveat that exemptions apply if necessary. The weakened bull case for oil has prodded me to make an exception to my own rule as I find myself thinking of every plausible reason for the market to be more bearish than positive in the near term.

    And like the good-one-point-or-two rule, I believe OPEC’s reaction to any weak turn in crude prices will be to respond first with a supply scare to counter that, then with more scaremongering on round two.

    Whatever the back and forth on this is, the events of the past week have produced too many new variables that look bearish in the near term for the oil market to ignore, hence my inclination in using the kitchen-sink model to tell them.

    And right on top of that unsightly heap is:

    Not-So-Good Economic News Out of China

    China's consumer prices faltered in September and factory-gate prices shrank slightly faster than expected, with both indicators showing persistent deflationary pressures for the largest oil importer and world's second-largest economy.

    China’s Consumer Price Index, or CPI, was unchanged in September from a year earlier, missing a forecast growth of 0.2%, and after a 0.1% expansion in August. Its Producer Price Index, or PPI, fell 2.5% from a year earlier, the 12th straight month in negative territory though the pace of decline slowed from August.

    "CPI inflation at zero indicates the deflationary pressure in China is still a real risk to the economy. The recovery of domestic demand is not strong, without a significant boost from fiscal support," said Zhiwei Zhang, chief economist at Pinpoint Asset Management. "The damage from the property sector slowdown on consumer confidence continues to weigh on household demand."

    A series of stimulus measures and a summer travel boom helped industrial output and consumer spending in China to rebound last month. Chinese refineries also ramped up output, driven by strong export margins. Total refinery throughput was a record 64.69 million metric in August, up 20% year-on-year and the fastest annual growth since March 2021, as crude processors ran at optimal rates to meet summer demand.

    That was the summer. Now with the weather turning cooler, China’s recovery story is also getting colder.

    It’s been the same since January. One good month in China is often followed by a couple or more months of bleak indicators. There are signs the economy is stabilizing. What’s missing is the sustainability of that recovery, despite multiple stimulus measures in place. The IMF on Tuesday lowered its growth forecasts for China for this year and next, due to the country's property crisis and weak external demand. China's property sector has yet to emerge from a deep slump despite a raft of policy support measures.

    Further out, some are predicting China’s demand for oil could peak by the end of the decade.

    “For 20 years, the oil market (has been) dependent on ‘China, China, China’,” Fereidun Fesharaki, chairman at Facts Global Energy, noted at an energy conference in September. “The story is coming to an end.”

    Saudi Assurance of Supply Despite Production Cuts

    Saudi Arabia’s state oil firm had informed at least four refiners in North Asia that it would supply them with the full contractual volumes nominated for November, Reuters reports.

    The pledge by Saudi Aramco ran against the very grain of what Riyadh had been publicly telling global oil markets — that its priority was about keeping the market tight, not assuring that supplies were generously available whenever needed.

    “The party line on this is that supply and demand for Saudi oil is stable despite the high prices now, given that Saudi OSP itself has been raised,” John Kilduff, partner at New York energy hedge fund Again Capital, said, referring to the kingdom’s official selling price for its Arab Light crude.

    “What the market sees instead is Saudi oil readily available to anyone outside of the US who wants it. All the kingdom wants are higher OSPs. In the real market where oil is bought and sold, no one talks of export cuts or market balancing, not the Saudis especially, because if they don’t provide their customers with full cargoes, there’ll be Russian and even US supplies to fulfill that.”

    IEA, OPEC Unable to Agree on Oil Demand; Market Believes IEA More

    After decades, the two leading forecasters of oil supply and demand are still not on the same page and the gap between them widened this week on potential crude consumption for 2024. The International Energy Agency, or IEA, predicted a sharper slowdown while producer group OPEC stuck to expectations for buoyant China-led growth.

    The two have clashed in recent years over issues such as the long-term oil demand outlook and the need for investment in new supplies. This week, the Paris-based IEA, which represents the world’s oil consumers, lowered its forecast for 2024 oil demand growth to 880,000 barrels per day from 1 million, suggesting that harsher global economic conditions and progress on energy efficiency will weigh on consumption.

    OPEC, or the Organization of the Petroleum Exporting Countries in its latest report, stuck to its forecast that demand will rise by 2.25 million barrels daily next year. The difference between the two forecasts - 1.37 million bpd - is equivalent to more than 1% of daily world oil use.

    Bottom line? The market tends to give the benefit of the doubt on oil demand to the IEA, which is just like how it believes OPEC’s pledges on crude production cuts — only to realize belatedly at times that it’s been made a fool of (case in point: Russia, until a few months ago, persistently produced more oil than what it promised Saudi Arabia since the start of their collusion on crude prices in 2015).

    Iran Sanctions Enforcement — It Won’t Be as Tough as Thought

    Treasury Secretary Janet Yellen says nothing Is ‘off the table’ as the United States considers new sanctions on Iran and Hamas for the Israel-Gaza war.

    The truth is that’s easier said than done.

    The crisis in Israel poses a new challenge for the world economy and the Biden administration, which has spent the last year working to combat inflation in the United States and to corral energy prices that have become volatile because of Russia’s war in Ukraine. Another war in the Middle East complicates those efforts by threatening to constrain oil supplies and send prices higher.

    Interestingly, the United States on Thursday imposed the first sanctions on owners of tankers carrying Russian oil priced above the G7's price cap of $60 a barrel, in an effort to close loopholes in the mechanism designed to punish Moscow for its war in Ukraine.

    But with Tehran, since late 2022, Washington has turned a blind eye to surging Iranian oil exports, bypassing US sanctions. The priority in Washington was an informal détente with Tehran so as to allow the world more oil supply in the advent of OPEC+ production cuts.

    As a result, Iranian crude output is estimated to have surged nearly 700,000 barrels a day this year – the second-largest source of incremental supply in 2023, behind only US shale oil.

    Thus, even if the White House is advocating a tough-as-nails approach on Iranian sanctions now, ultimately the amount of oil snagged from the mullahs in midsea might be nominal.

    In fact, the administration will likely be more effective in denying Iran some of the cold cash it needs from oil.

    Yellen raised exactly that possibility when she said Washington could re-freeze the $6 billion in Iranian funds unfreezed last month in exchange for the release of American hostages. That money is supposed to be used only for the purchase of food, medicine, and other humanitarian goods.

    “These are funds that are sitting in Qatar that were made available purely for humanitarian purposes, and the funds have not been touched,” Yellen said, adding: “I wouldn’t take anything off the table in terms of future possible actions.”

    So, money, more than oil, might be at stake in any redoubling of sanctions efforts on Iran.

    Record US Production, Exports That Defy Story of Falling Rigs

    US oil production has hit record highs of 13.2 million barrels per day, eclipsing a peak not breached since the outbreak of the coronavirus pandemic three years ago, government data showed.

    Crude oil output in the United States grew by 300,000 barrels per day during the week to October 6 from the prior week’s level of 12.9 million barrels daily to reach a new high, according to the Weekly Petroleum Status Report of the Energy Information Administration, or EIA.

    The EIA has been estimating higher crude production for the United States in recent months, citing improved efficiency in output at US shale oil basins despite a sheer cutback in the number of oil rigs actively deployed by drillers.

    “It’s staggering how far US oil production has come in just a few months this year to reach this record high cited by the EIA,” said John Kilduff, partner at New York energy hedge fund Again Capital.

    Oil longs will likely dispute the EIA’s estimates, arguing that there is very little appetite among US producers to put out more crude.

    Bears will also argue that American oil drillers are behaving more like OPEC these days despite US antitrust laws prohibiting any collusion for control of supplies in an economy.

    Shale oil wasn’t like this once. It was one of the original great tales of American dynamism and innovation that showed a royal finger at the Arabs and their oil. First-generation Mom and Pop drillers in the fracking era practiced the true American spirit of competition and independence.

    Of course, the price bust that followed brought in Big Oil to swoop up the weak prey and their leases. And Big Oil is in the same bed with Aramco (TADAWUL:2222), the Saudi state oil company.

    So today, we have an effective OPEC model as well in America despite its antitrust laws, with domestic drillers looking to the Saudi Energy Minister for cues on what to do, while keeping up with the guise that their main motive is to reward shareholders.

    The truth is at current prices, one can pretty much stick a rig anywhere and make a pile. At the end of the day, its politics on both sides: the administration wants to prioritize renewable energy; its main task is no drilling in conservation areas. Drillers, who are largely Republican, do not want to reward the president with more oil as he seeks reelection.

    Back to US oil volumes — along with record production, exports of crude also hit all-time highs during the first half of this year as American oil-filled pockets of demand underserved by OPEC+ production cuts.

    Crude shipments from the United States period averaged 3.99 million barrels per day in the January-June period, setting a record high for any first half since 2015 when the US ban on crude exports was repealed, the EIA said.

    It noted that exports rose almost 20% in the first half of this year compared with the first six months of 2022, rising by 650,000 barrels daily.

    Bottom Line

    OPEC+, the global alliance of oil producers led by Saudi Arabia and Russia, has been aggressively cutting crude supplies on the global market in recent months, citing uncertainties about demand. The Saudis have pledged to cut 1 million b/d until the end of the year while Russia has said it will reduce daily supply by 300,000 barrels. The rest of the 23-nation strong OPEC+ is contributing about 1.5 to 2.0 million barrels per day in cuts.

    The EIA said Europe was the largest regional destination for US crude oil exports by volume, at 1.75 million b/d, led by exports to the Netherlands and the UK.

    Asia was the regional destination with the next-highest volume, at 1.68 million barrels daily, led by exports to China and South Korea. The United States also exported significantly smaller volumes of crude oil to Canada, Africa, and Central America, and South America.

    Although exports increased in the first half of 2023, the United States still imports more crude oil than it exports, meaning it remains a net crude oil importer. The United States continues to import crude oil despite rising domestic crude oil production in part because many US refineries are configured to process heavy, sour crude oil rather than the light, sweet crude oil typically produced in the United States.

    The imports are the give-back to OPEC in this part of the story. But the more riveting narrative is US production returning to all-time highs just within three years, something might few imagined in the early days of the pandemic.


    Disclaimer: The aim of this article is purely to inform and does not in any way represent an inducement or recommendation to buy or sell any commodity or its related securities. The author Barani Krishnan does not hold a position in the commodities and securities he writes about. He typically uses a range of views outside his own to bring diversity to his analysis of any market. For neutrality, he sometimes presents contrarian views and market variables.

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