The oil market has been moving in and out of contango, with a shallow backwardation at present betraying expectations of tighter supply going forward and into 2019. Brent broke through the $75/bbl mark on 24 August after remaining range-bound at $70-75/bbl for most of August.
Going forward, a consensus has formed among forecasters that crude oil demand could well reach 100m bbl/day by the end of the year, with both OPEC’s and the Paris-based International Energy Agency’s forecasts expecting a break through this symbolic threshold.
A weakening of the US dollar has proven supportive of global crude prices, with the US dollar index peaking in mid-August to shed about 2.28 percentage points between 14 August and the end of the month. The greenback has since regained a little strength but remains below its previous surge levels.
In the meantime, the US Federal Reserve has been pacing up the end of quantitative easing, hiking up its policy rates in line with its inflation target and leaving investors expecting another two such hikes by the end of 2018.
In practice, this means the cost of borrowing funds in the US will increase.
This will help maintain some capital discipline among US oil exploration and production companies and force them to come off from their past “production-at-all-cost” rationale. As a result, the crude production upside from the US will remain limited by the constraints on capital expenditure.
The spread between WTI and Brent showed a general widening trend throughout 2018 as the US ramped up production. In 2015 the country lifted its ban on crude exports after 40 years, and domestic infrastructure is not yet prepared for the transfer of large volumes of crude overseas.
Elevated US production therefore caused a national supply glut until June, depressing the price of WTI.
An outage at Canada’s Syncrude facility in June, which can produce up to 350,000 bbl/day, caused the price of WTI to rally, narrowing the spread to Brent. Once this disruption became priced into the market in July, the spread continued to widen at a similar rate.
The US call to OPEC in June to raise output has shown, if anything, that the country is not yet in position to be the swing producer it purported to be. Yet, the US has had a large impact on prices in August by throwing its political weight around.
Crude oil futures have tightly tracked US geopolitical developments, firmly supported by the impending sanctions on Iran while at the same time dampened by a protracted trade feud with China.
The sanctions follow the US withdrawal from the Iranian nuclear deal known as the joint comprehensive plan of action (JPCOA).
The deal, signed between Iran and six other world powers including the US, began to erase the crippling sanctions that had been placed on the country.
The US withdrawal from this agreement and the subsequent reintroduction of sanctions on Iran have sent bullish signals throughout the oil markets.
The first round of sanctions began to bite in early August, and will ratchet up on 4 November when the embargo extends to Iranian heavy crude oil exports.
The US’ avowed objective is to reduce Iranian oil exports to zero, and investors have struggled to gauge what portion of this claim would actually hit the market this winter.
A resilient supply chokepoint has been Libya, where political turmoil in the country’s Oil Crescent for much of June and July had dented the production of light sweet crude by almost 300,000 bbl/day against the May levels, according to OPEC data.
The recovery of Libyan oil exports has been actively tracked by the market, with potent effects on the prices of competing regional grades.
The supply disruptions in Iran and Libya on a macro scale both impacted the price of Brent.
However, the impact can be seen regionally on opposing grades of crude.
The loss of Libya’s light sweet crude into the market, after the first force majeures were declared in mid-June, was bullish for the CIS grade Azeri Light.
Conversely, when exports resumed in mid-July, competition pushed the grade’s differential down.
With the US sanctions on Iran’s oil exports set to begin in November, exports from the country are already beginning to wilt.
SANCTIONS LIFT COMPETING GRADES
Buyers have sought to substitute the comparable heavy sour grade Urals NWE in place of Iranian crude.
This uptick in demand has pushed its differential to a 2018 high, and the recent hike of Saudi official selling prices to Europe will add further upward pressure.
On the flip side, trade tensions between the US and China continue to weigh on global oil prices, with both countries responding to each other in a tit-for-tat series of tariff escalations.
Market participants fear that the spat between the world’s two largest economies could weaken global demand growth and in turn depress the oil price.