Two major geopolitical events have been affecting the volatility of oil prices: President Donald Trump is sticking to his pledge to cut off Iran from the rest of the world with economic sanctions, squeezing the country’s energy trade. As the result of these sanctions, Iranian oil exports are forecast to fall by between 700,000 to 1 million barrels per day, a range consistent with the 2011 sanctions, when Iranian exports fell by 900,000 barrels per day. Today, three months before the November deadline when the sanctions are due to take effect, Iran’s outflow has already fallen by around 430,000 barrels and the nation has to rely more on its own fleet of tankers to carry oil to its customers, clearly showing that buyers are hesitant to continue purchasing Iranian oil. On the geopolitical side of the equation, the trade war between the US and China, the two largest economies in the world, is starting to weigh heavily on the energy sector. China’s main producers have received instructions from Xi Jinping to increase domestic oil production in order to safeguard the country’s energy security. China will apply 25% duties on American diesel, gasoline and other petroleum products, but US crude is excluded from the latest list of sanctions. In June, China was the biggest foreign buyer of American crude, importing a record 15 million barrels that month.
Demand for oil this year is projected to remain robust, supported by global GDP growth. This demand is coming mainly from China and India, with Chinese imports of US crude having more than doubled since the beginning of 2017. Estimates are stable at an average growth of 1.5 million barrels per day, in line with demand growth’s three-year average.
On the supply side, OPEC’s decision to increase output again to compensate for production losses in Iran and Venezuela is already taking effect, with the group adding more than 300,000 barrels in the last month. In the US, the nationwide crude stockpile decreased by more than 10 million barrels, while production remained flat at around 10.5 million barrels per day. The Energy Information Administration reduced its 2019 forecast for domestic oil output to an average of 11.7 million barrels per day, but reiterated that the US is set to become the world’s top oil producer in 2019, reaching 12 million barrels per day before 2020. It is interesting to note that the US oil rig count (an indicator of future oil production) has been flat in the past two months.
Despite the recent correction, the commodity price remains well above the average cash flow breakeven levels of integrated oil companies. The rebound in oil prices helped the energy supermajors print strong Q2 results with much higher profits but weaker-than-expected cash flows. At current prices, these companies should continue to post strong results in the next couple of quarters.
Pierre Melki
Equity Analyst Advisory & Research