Commodities | Sep 24 2018
Having balanced the oil market since deciding to withhold barrels in January 2017, OPEC and its cohorts are now faced with an opposing dilemma, increasing output enough to cover expected shortages over the next few months.
-Are there sufficient barrels in the market to make up for lost Iran supply?
-Under-investment in oil supply a growing concern
-Yet Russian investment increasing at a significant rate
By Eva Brocklehurst
Ahead of the joint meeting of OPEC and non-OPEC countries to consider the current declaration of co-operation, analysts reviewed the outlook for the oil market. The questions centred on spare capacity, as Iran's production starts to decline, as well as plans for conforming to production constraints, if required, going forward.
CIBC Capital Markets believes the OPEC alliance has successfully balanced global oil markets since agreeing to withhold 1.8m bpd since January 2017. This time, OPEC and cohorts are faced with a diametrically opposite decision, obtaining consensus for an increase in output enough to cover shortages from Iran and Venezuela over the next few months.
CIBC suspects, based on analysis of August supply data, that there are sufficient barrels in the market to make up for losses of supply. The question now is whether the alliance has both the capacity and desire to continue balancing the market.
ANZ analysts point out, despite an increase in production agreed on in June, the market continues to tighten. The falls in Iranian crude exports are larger and arriving earlier than expected, already showing signs of being affected by the reimposition of US sanctions.
Spare capacity is also falling sharply and the analysts suggest the market is exposed to supply-induced price shocks. Iran appears to be storing increasing amounts of crude on tankers in the Persian Gulf, according to Bloomberg ship tracking data. The ANZ analysts suggest this comes at a sensitive time for the market.
While Saudi Arabia and Russia would have been across the potential for a fall in Iranian exports, the analysts suspect that their ability to balance the market is becoming even harder. The drop in exports from Iran appears to be stemming from a lack of interest from key purchasers, namely China and India. China has just endured its longest period without receiving Iran crude in three years and the reason for the hiatus remains unclear.
In the short term, Morgan Stanley suspects supply risks will outweigh concerns regarding demand. Low inventory, falling spare capacity, constrained US production and the Iranian sanctions are skewing the price risk to the upside.
The broker also observes the northern summer was characterised by several OPEC members raising output aggressively ahead of the expected losses from Iran. This coincided with a period of weak Chinese imports. However, these factors have been reversing in recent weeks.
Morgan Stanley reiterates a call for Brent to reach US$85/bbl in coming months. Minimal spare capacity and low inventory are supporting prices. Inventory in July, expressed in days-of-demand, reached the lowest levels since the start of 2011.
Meanwhile, spare capacity is low by historical standards and the majority is in Saudi Arabia, where realising this capacity likely requires additional drilling. Morgan Stanley believes under-investment is a growing concern, which will eventually impact on the balance of supply/demand.
A reduced rate of project sanctions in recent years is emerging as a critical issue and a fall in the oil price now would exacerbate supply challenges in the future. The broker notes, expressed in a trade weighted basket of emerging market currencies, crude prices are near 2013/14 highs while gasoil has already surpassed previous records. Yet global growth in demand for gasoline and middle distillates is yet to deviate from the trend rate.
Morgan Stanley believes, while exports from Iran have already fallen sharply, the risks remain to the downside. The broker argues that consensus overstates production growth from the US, while challenges in Venezuela and Angola are significant.
Russia
On the other hand, Citi continues to envisage substantial upside to Russian liquids production. The broker estimates Russian producers still have around 240,000 bpd of idle capacity available from the 410,000 bpd estimated back in May. In terms of drilling, Russian producers did not ease up during the period when OPEC was restraining its production.
The broker suspects that the US, Russia and Saudi Arabia combined are able to supply enough oil during the last quarter of 2018 to limit a spike in the price above US$80/bbl. Russia appears to be at the head of the advance. Citi envisages Russian output headed to 12m bpd by 2020, as greenfield activity remains unusually high and fields are being ramped up at an impressive rate.
Going forward, Morgan Stanley believes demand represents the main risk to oil prices. Emerging markets are driving growth but higher US interest rates and concerns over trade have weakened their currencies in recent months relative to the US dollar. This is particularly the case of Brazil, Mexico, Argentina, Russia, South Africa and India. Nevertheless, the broker considers the risks to demand at this stage are not strong enough to revise its global oil figures materially.
Stock Performance
Morgan Stanley expects returns in the Australian energy sector to be supported by strong oil prices as the sector has outperformed the ASX 200 in the year to date, with returns of 11.3% versus 5.2% in local currency terms.
The broker's oil strategist retains a long-term positive outlook for oil prices, which should support stocks. A renewed capital expenditure cycle could also extend returns. The analysts consider it likely that upstream capital expenditure will increase, improving capacity and potentially extending the sector's performance further into the future.
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