2018 has so far been a very unpredictable as well as a fickle year for the energy industry. Brent has seen a 20 USD jump since January, rising from 69.08 USD/barrel to 82.03 USD/barrel. A similar trend is followed by various other blends, including the West Texas Intermediate WTI. This course has had profound market and geopolitical implications. The tension in the Middle East, the looming trade wars, the degenerating economies, all contribute to the energy crisis which has enshrouded the world.
The primary causal link for the precariousness of oil prices and the supply disruptions boils down to the emerging trade sanctions on Iran. Iran currently supplies 2 million barrels per day of the 97 million barrels pre day of global oil demand. Sanctions are supposed to go into effect on the 2nd of November 2018. The contingent production cut has a lot of investors and buyers increasingly anxious. At the start of this year the oil market was already considerably tight as compared to previous years. The unanticipated move by the US government to pull out from the Iran deal made the already tough situation untenable. As the demand for oil grows behind the thirsty booming economies of Asia, energy supplies are having a hard time catching up.
Historically, the upstream oil and gas industry had learned a very important lesson following various oil market disruptions. The lesson being the notion of spare crude oil capacity. In this crucial and invariably oil dependant era, petroleum market disruptions translate into chaos and anarchy, which greatly affects consequential industries such as aviation and manufacturing. To avoid this ‘Rube Goldberg’ play out of collapsing industries, spare capacities have always been an important alleviating factor. The country with the most sizeable crude oil spare capacity is—with no surprise—the Kingdom of Saudi Arabia. With the Iranian oil seeping out of the market, the Saudi spare capacity—which ostensibly stood at 1.5 to 2 million barrels—should have comfortably absorbed the transition of the market share from the Iranians to the Saudis. Recently, however, following the failure of the Saudi authorities to properly bringing the spare capacity online mentioned previously, there have been severe doubts on the veracity of the number mentioned by Khalid A. Al-Falih, the minister for Energy, Industry and Mineral Resources, who is also the current chairman of Saudi Aramco. In the event that the Saudis fail to bring the entire spare capacity online swiftly, the repercussions could be evident and long lasting.
If the sanctions on Iran and the dubiously held spare capacity of Saudi Aramco wasn’t bad enough, the degenerating economy of Venezuela has diminished more than 1.5 million barrels of its oil production. Moreover, Nicholas Maduro’s pugnacious stance to the United states has rendered the nation isolated, with currently no viable oil market. This gap in Venezuelan market share has provoked oil giants like Exxon to venture out for more upstream projects around the globe. As a result The rig count over the past three years has shown a steady increase. The increase in investment activity in the oil production sector has prompted an increase in the favourability for oil stocks and futures. The contingency of oil demand and supply gap may seem to have a positive affect for the oil market short term. Long term, however, unsustainable oil prices contribute to the over all market instability. More than anything, to proliferate, the oil market needs long term stability in terms of prices.
Adding to the oil market instability is infamous the trade standoff between the United States and China. However, the trade war isn’t just restricted to China any more, with Canada, Mexico, and the European Union being recent additions to parties being involved in trade wars with the United States. The confrontation between the US and China initiated after the US imposed tariffs to try and coerce manufacturing industries to shift operations from China to the back home. China retaliated with its own round of tariffs on US soybean and meat industry. Although China imports a bulk of its natural gas from the US, the contention has forced China to add gas to a list of commodities to be taxed. Recently, China showed a desire to implement a 10% duty on natural gas imports from the United States. This bold move by China will provoke Chinese importers to probe for more reliable gas sources, which would include Qatar, Iran, and possibly Russia. One possibility keenly observed by the Chinese in early September was the market growth in Canada. Shell recently showed serious interest in investing 40 billion dollars for a LNG liquefaction plant on the northern coast of British Columbia. Canada also has the reserves and the industry infrastructure to be an important contender for global LNG market share. Moreover, Canada’s geographical location, and its relatively loose tariff policy with China made this plan very lucrative. Now, however, in a recent turn of events, the new NAFTA agreement has made it tougher for Canada to work with China in isolation. According to a new clause added in the NAFTA, a nation trying to trade with a non-market economy must always notify other members. This move shows the rigidity of the US on the possibility of loosing their market share, and puts the Chinese in a difficult position with regard to Canadian exports.
There are a plethora of aspects which add to the precariousness of the oil market. The issues from the Middle East, to South America, to China, all contribute to the turbulence experienced by the oil market. One certain aspect is the inability of markets to slow down or mitigate any time soon. More instability will follow, which would invite more bullish prices for the future.