Oil: hundred-dollar mark in sight
In two years, the oil market has changed direction, moving from a surplus of oil to what will very likely be a supply shortage in 2019 and 2020. Since the third quarter of 2018, the market has been faced, in particular, with the US administration’s determination to completely eliminate Iranian oil exports; at the same time, growth in US production is set to slow and Venezuelan production still appears unable to recover. There is still plenty of uncertainty over the effectiveness of US sanctions on Iranian oil, US producers’ ability to remedy transportation difficulties, and the extent of the decline in Venezuelan production. Indeed, it is still too early to tell how far the big buyers of Iranian oil – China, Turkey and India – will be able to circumvent the extraterritoriality of US sanctions and the US dollar in their dealings with Iran, or to benefit from exemptions in return for “substantial” reductions in imports of Iranian oil.
Even assuming a moderate scenario, particularly as regards the extent of US sanctions, the drop in Venezuelan production and growth in global demand over the next two years, the oil market will need OPEC’s help to balance, not only in 2019 but very probably in 2020.
Production by the United Arab Emirates and Kuwait is expected to very quickly peak from as early as 2019. Assuming a stable environment in Iraq – notably in the southern city of Basra, home to the oil terminals from where the vast majority of Iraqi oil is exported – Iraqi production should increase. However, the oil market’s equilibrium will mainly depend on Saudi Arabia. Saudi production will need to increase by almost a million barrels a day in 2019 to avoid stocks drying up. This will leave OPEC and Saudi Arabia with very little excess capacity: just over 1.2 million barrels a day, according to figures from the International Energy Agency. Such a low level of excess capacity within OPEC (hitherto only seen in 2008 and 2011) will expose the oil market to the risk of soaring oil prices in the event of further production losses (even if only short-lived) in some countries where the political environment is unstable, such as Libya, where the recent attack on the headquarters of the national oil company shows just how vulnerable the country’s oil industry is to infighting. Saudi Arabia has clearly realised its production will be greatly in demand. It recently awarded a contract to a US company to increase capacity at one of its major fields.
While the main source of disruption to the oil market in 2019 will be US sanctions on Iran, International Maritime Organization (IMO) rules on fuel quality, set to come into force on 1 January 2020, are likely to throw the diesel market out of balance in 2020. The diesel market is one of the most buoyant and profitable petroleum product markets for refineries. It is also the market whose growth supports growth demand for oil. The OMI’s requirement to use low-sulphur fuels from 2020 is likely to trigger increased demand for sulphur-free diesels, at the expense of the heavier, more sulphur-rich fuels currently used by most commercial fleets. As such, these new regulations could indirectly push up the price of oil. Strong demand for diesel in 2008 already contributed to a dramatic rise in oil prices.
In this environment, in the absence of geopolitical change in the Middle East or a severe economic recession, the price of oil is set to continue to gradually rise in 2019 and 2020. Our scenario is based on an average Brent price of US$80.5 a barrel in 2019 and US$85.5 a barrel in 2020. Oil prices are likely to be volatile, sensitive to any event that could compound the oil supply shortage. As such, the possibility that oil might exceed the symbolic US$100 a barrel threshold cannot be ruled out.