Monday, 17 August 2015

Oil - shale giveth and Iran taketh away

Oil markets to remain over-supplied through 2016.

The consensus among oil analysts was that 2015 would be a bad year for oil prices, but things should improve after that. Their thesis was that lower oil prices would make the business of high-cost US shale oil producers unviable, pushing some of them out of the market. This should slow down the growth of oil supply, allowing demand to catch up and prices to recover. The consensus is now changing, and the reasons is: Iran.

Let’s take this step by step. In 2015, oil markets are expected to be over-supplied by around 0.8m barrels per day (b/d), even if OPEC sticks to its production ceiling of 30m b/d. Consequently, oil prices should remain low—in the $50s range—during the year.

How about 2016? US shale is doing its bit to rebalance the market. The US is expected to add only 0.3m b/d to existing production (compared to 0.9m b/d in 2015 and a whopping 1.4m b/d in 2014). As a result, demand growth was expected to outpace supply growth by around 0.3m b/d, reducing inventories and pushing up prices. This was the consensus before Iran.

Following the agreement on its nuclear programme and the prospect of lifting economic sanctions in 2016, Iran is expected to return to the oil market. Estimates vary on how much additional oil Iran could produce once the sanctions are lifted, but they range between 0.2-0.8m b/d. Whatever it is, it will almost certainly wipe out the 0.3m b/d of excess demand which was expected to drive the recovery in oil prices. With the return of Iran, inventories are expected to stabilise, or even increase, and prices will continue being low (again in the $50s range) into 2016.

In theory, Iran should not matter for the oil market. After all, it is a member of OPEC and the cartel has a production ceiling of 30m b/d. If Iran produces more, other OPEC members should produce less to maintain the ceiling. But this is unlikely to happen in practice: OPEC producers will probably continue pumping as much oil as they can to meet their financial obligations in an environment of low oil prices.

The latest production data support this. In July, Iran’s supply increased to its highest level since 2012. As a result, OPEC production reached a three-year high of 31.5m b/d, well above the self-imposed ceiling.

If this is a sign of things to come, then whatever shale gives to reduce excess supply and rebalance the market, Iran will take away. Oil markets will remain over-supplied through 2016.

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