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China and Iran Reshape Oil Market Thinking

Business, China, Company Strategy, Economics, Oil & Gas
By John Richardson on 15-Jul-2015


By John Richardson

ON Monday, I discussed how a generation of analysts have grown up never having experienced a prolonged period of weak economic growth in China.

Because these analysts were unable to imagine a sustained downturn in China, they bent their theories to fit a set of facts that have consistently pointed to more difficult times ahead since as early as 2011.

The great news, as I again said on Monday, is that the consensus on China has finally shifted to where it could and should have been back in 2011.The catalyst has been the decline in local stock markets. A good example of this shift in the majority view was a 14 July article in the Wall Street Journal, which concluded with this  apposite statement:

The easy economic gains are over. Now there is no choice but to begin the hard work.

The same process is now taking place in oil markets, where the catalyst will be the historic nuclear deal between Iran and the West.

A whole generation of analysts have grown up with the notion that the natural price of crude is around $100 a barrel.

What these analysts failed to spot several years ago was that misplaced US Fed economic stimulus encouraged too much investment in physical oil supply, and too much gambling by paper-market speculators who went perpetually long on crude.

They were equally unable to grasp that supply wouldn’t automatically shut down when prices fell, and so they assumed that if prices ever fell much below $100 a barrel, production cutbacks would soon return prices close to this magic level.

Then when they realised they had got this wrong, they shifted ground slightly and started to argue that the New Normal for oil prices was $60-80 a barrel.

But now we have the Iran deal, which by itself is significant for supply, as the Guardian pointed out in another 14 July article when it wrote that:

In terms of Iran’s ability to sell crude, I think that is where we will see the most immediate loosening up of restrictions. Iran has between 40 and 50 million barrels of crude at sea.

 Expect this crude to come to the market in short order. They will start competing fiercely to regain market share that they have lost to their Persian Gulf neighbours.

Unfortunately for Iran the timing couldn’t be worse. Oil prices are depressed and already there is a glut of oil on the market. Adding Iran’s crude will put further downward pressure on oil prices.

But even if there had been no nuclear deal, oil supply was already very long. Last Friday, for example, the International Energy Agency said the following:

It remains that the oil market was massively oversupplied in 2Q15, and remains so today. It is equally clear that the market’s ability to absorb that oversupply is unlikely to last.

Onshore storage space is limited. So is the tanker fleet. New refineries do not get built every day. Something has to give.”

Thanks to Iran, I think people will now focus on all the issues surrounding supply.

As for the demand side of the story, this is where we come in full circle: It was the entirely false notion that nothing was wrong with China’s economy that also helped to keep prices at around $100 a barrel.

So, as more and more people grasp the realities of supply and  demand, I can see no reason why prices will not head back towards their historic average of $30 a barrel.