Global Oil Supply Glut Gives Trump Room To Maneuver On Iran
Stop me if you’ve heard this one before. Tensions in the Middle East escalate to a fever pitch, one side strikes a stunning blow in the never-ending “shadow war” against American hegemony in the oil-rich region, and crude prices spike on fears of an oil shortage.
But then tensions calm, the oil keeps flowing and prices come back to earth.
As the unprecedented attacks on key Saudi Arabia oil facilities showed last September, it’s not easy in this era of abundance to establish a geopolitical risk premium in global oil markets or sustain a price rally.
That’s why those traders betting on higher oil prices after Friday’s killing of Gen. Qassem Soleimani, Iran’s most senior military commander, in a U.S. drone attack in Iraq should err on the side of caution.
Iran has pledged to retaliate, and it showed last year that it can significantly disrupt Middle East oil markets in several ways, including pestering tankers in the Strait of Hormuz, hitting critical pipelines and ports, and, most spectacularly, attacking Saudi oil fields and facilities, an event that temporarily halved Saudi oil production.
But perhaps the most telling story of oil markets in 2019 was how quickly oil prices retreated to pre-attack levels in the days following that September 14 attack.
A well-supplied oil market, both in terms of spare production capacity and inventories, rendered the attacks a virtual non-event. That’s incredible given that the loss of production from OPEC-leader Saudi Arabia – known as the world’s “central banker” for oil – was, in the past, considered a doomsday scenario by veteran oil analysts.
Sure enough, the price of oil on the international benchmark Brent hub pushed higher on Friday, at one point peaking at $69.50 – its highest level since the Saudi oil facilities were attacked. But gains were quickly pared as the session wore on, with the price closing up around $2 at over $68 a barrel.
There are some reasons to believe that “this time will be different” and that a real risk premium of perhaps $3 to $5 a barrel could now be built into oil prices.
Unlike in September, oil prices at the end of the year were on a roll before the January 3 killing of Soleimani, boosted by OPEC’s latest supply cut deal and an improved global demand outlook as a result of the phase one trade deal between the U.S. and China.
Another factor favoring higher prices is the slowing of U.S. shale oil production growth. That would be sufficient in a normal market to prompt a rally in oil prices if retaliations escalate between Tehran and Washington. The reality, though, is that it may take a full-blown war in the region to make oil prices move substantially higher – such is the extent of the oversupply of oil in the market at the moment.
Even with the combined effect of slower non-OPEC production growth and deeper OPEC cuts, the International Energy Agency recently stated there could still be a surplus of 700,000 barrels a day in the global oil market in the first quarter. Other analysts see the surplus in the first half at 1 million barrels a day or higher.
It’s important to remember that Saudi-led OPEC and its allies are deliberately holding back roughly 2 million barrels a day of production to make room for still growing non-OPEC supplies, to keep oil markets balanced and support oil prices.
That is 2 million barrels a day that could be brought on virtually overnight if necessary.
The IEA assesses global spare capacity at roughly 3.1 million barrels a day, of which some 2.1 million barrels a day is in Saudi Arabia. Another source of supply resilience is due to come online later this year when the Wafra and Khafji fields in the Saudi Arabia-Kuwait “neutral zone” return, adding roughly 500,000 barrels a day.
Of course, that’s contingent on oil capacity in Saudi Arabia, the UAE, and Kuwait – all U.S. allies – remaining unaffected. That remains an unknown as Iran looks for targets to retaliate against without directly attacking U.S. forces.
Tehran may well believe it has to respond to the U.S. drone attacks to save face with hardliners within its government –Soleimani was immensely popular. But Iran is typically strategic in its attacks on the West, depending on proxies in Lebanon, Iraq and Yemen to give it deniability.
But there are also roughly 3 million barrels a day being held back by U.S. sanctions and civil strife. Sanctions on Iran and Venezuela won’t ease anytime soon, but the output from conflict-stricken nations like Libya, Nigeria, South Sudan, Yemen and Syria could increase if political and security conditions in those states improve.
That is a massive amount of spare capacity – even if some of it can’t be tapped immediately, it has a significant effect on oil-market psychology.
The supply cushion doesn’t end there either. Consumer nations around the world have built up massive inventories of crude oil and petroleum products, both in commercial and strategic stockpiles. Many import-dependent Asian countries have been preparing for a supply disruption in the Middle East since tensions with Iran started escalating last Spring.
As of November, the IEA gauged OECD commercial petroleum inventories at roughly 2.9 billion barrels, equivalent to the trailing 12-month average and enough to cover about 60 days of demand.
Meanwhile, strategic petroleum reserves in the OECD are 1.5 billion barrels, and China is believed to now have around 1 billion barrels stockpiled – enough to cover more than 80 days of demand. All that surplus oil is helping to offset geopolitical fears. The bottom line is that the world should have more than sufficient crude oil on hand to cope with any slowdown caused by Iran.
Another important factor that shouldn’t be discounted is the United States’ recent transformation into a net exporter of petroleum after decades of being a major importer. The combination of a decade of rising production thanks to the shale boom and growing exports of refined petroleum products, has redrawn long-standing oil trade patterns and reduced dependence on Mideast oil significantly for many big consumer nations.
The very fact that the Trump administration can challenge Iran so aggressively is because the United States – and the global economy – is no longer beholden to Mideast oil as it was in the past.
None of this is to say that recent events can’t have a significant impact on oil markets.
All-out war in the Middle East between Iran and its many proxies and the United States and its allies in Saudi Arabia, the UAE, Kuwait, and Israel, would be an extremely messy affair. Iran already targeted oil facilities and shipping lanes before the killing of Soleimani. And the front line of any conflict may very well be Saudi Arabia and Iraq – OPEC’s two largest oil producers.
That can’t be discounted.
But with non-OPEC oil supplies growing rapidly, and an ample spare capacity cushion and huge oil inventories to lean on, the market looks well-prepared for whatever tomorrow brings.