A cursory reading of oil-related headlines points to one thing: Prices should be higher.
Saudi Arabia reported drone attacks on two pumping stations on Tuesday. That followed the weekend’s mysterious incident off the coast of the United Arab Emirates that left several oil tankers damaged. U.S. sanctions are tightening on Iran, which in turn threatens to start peeling back its own compliance with the nuclear deal Washington has abandoned. Some of Russia’s oil exports are contaminated. Saudi Arabia has cut supply by almost 1.3 million barrels a day since November. And Libya and Venezuela are still Libya and Venezuela.
Don’t get me wrong: Brent crude is up by almost a third so far this year. Still, that only partly reverses the swan dive in late 2018, and prices have flattened out at about $70 despite the marked increase in geopolitical tension.
Beneath the headline price, there are signs of creeping concern. Hedge funds’ net length in Brent crude-oil futures and options has been climbing steadily since early March, albeit with the pace slowing this month. This coincides with time-spreads — which measure the difference between oil-futures prices for different dates — indicating conditions have tightened in the oil market over the past couple of months. Meanwhile, refining margins have risen after a dreadful first quarter and are holding steady for now.
If we are going to see a meaningful increase in oil prices, then the third quarter is the likeliest time for it. Apart from the potential for further incidents (and, no doubt, endless bellicose rhetoric) in the Middle East, there’s the simple fact that demand should peak for the year then. Refinery runs are forecast by the International Energy Agency to rise by 2.2 million barrels a day relative to the current quarter.
That number is important. The wash-out in oil prices in the fourth quarter of 2018 saw a perfect storm of a surge in crude-oil production running into unusually weak refining activity. Crude-oil supply outpaced demand by 2 million barrels a day, according to IEA estimates. Meanwhile, refinery runs fell not only quarter-on-quarter (as they normally do in the final three months of the year) but, unusually, year-over-year, too.
With that backdrop, the next two meetings of OPEC and its partners — a technical meeting this weekend and a full ministerial meeting late next month — look like foregone conclusions. Saudi Arabia, burnt by Washington’s bait-and-switch on sanctions waivers last year, has every reason to wait for early signs of tightness in oil markets translating into meaningfully higher prices this summer. Remember, too, that Riyadh is still unable to balance its books at $70 oil.
Even if the summer could bring higher prices, though, the market’s quiescence today in the face of such provocations shouldn’t be dismissed as a mere curio. As this recent analysis by Andrew Stanley at the Center for Strategic & International Studies demonstrates, oil is at $70 a barrel despite massive quantities being kept off the market by OPEC and chums, whether voluntarily or not. OPEC production in April was 3.8 million barrels a day lower than its peak in November 2016, just before cuts were set, according to Bloomberg data. Those cuts will no doubt be extended yet again next month, as we close in on the third anniversary of what was originally a six-month agreement.
The common thread in all the reasons for bullishness I cited at the start is that they pertain to supply. They are supply shocks. Later this year, they will be joined by another in the shape of impending new rules on marine-fuel standards.
Supply shocks tend to boost prices in the near term but also force sticky adjustments to demand. Which brings us, of course, to this week’s other headlines, regarding the escalating trade war between the U.S. and China. As much as a worsening situation in the Middle East stokes expectations of higher oil prices in the second half of 2019, deteriorating trade conditions as tariffs begin to bite can only pull the other way. As it stands, oil demand growth in China and India — which together account for almost half the IEA’s forecast for global growth this year — appeared to take a breather in April. This came alongside the worst car sales data for India in eight years and continuing weakness in China’s autos market, the world’s biggest by volume. As I wrote here, trade friction will exacerbate that.
Despite this changed environment, and the increase in oil prices over the past four months or so, the IEA’s forecast for global growth in consumption is essentially unchanged versus December. As much as you might think there’s complacency about threats to supply, you could argue there’s some catching up to do on demand too.