Oil prices rise due to US sanctions on Iran, forcing inventory drawdown in the fourth quarter. This will keep the seasonal spike modest for tanker rates.
The countdown for US sanctions on Iran has begun, but oil prices have started to rise well before the actual deadline. The recent surge in prices, with Brent touching $85 per barrel, looks at odds with a market that has remained well supplied. Despite the decline in Venezuela’s oil production, coupled with shrinking exports from Iran, other OPEC producers have managed to fill the void. However, the real test for the market will be the fourth quarter of 2018, when the seasonal surge in global oil demand is set to coincide with the deadline for Iran sanctions.
According to the International Energy Agency (IEA), oil demand in the fourth quarter will rise by 500 kbpd (quarter on quarter) to 100.3 mbpd. Although non-OPEC supply and NGL production by OPEC members are expected to rise by 100 kbpd each, the market will still need an extra 300 kbpd of crude from the cartel to meet the seasonal spike in demand.
In addition to the seasonal spike in demand, OPEC producers will also have to fill the loss of supplies from Iran and Venezuela in the coming months. Venezuelan production, which declined to 1.24 mbpd in August from 1.6 mbpd at the beginning of the year, is likely to dip further to 1.1 mbpd in the fourth quarter. As far as Iranian production is concerned, there is uncertainty regarding the actual impact of US sanctions, but the country’s oil production declined to 3.63 mbpd in August 2018 from 3.81 mbpd at the beginning of the year. Recently, the US has signalled that it will consider giving waivers on Iranian oil, but in our opinion the impact of sanctions is likely to be similar to that of 2012, when Iran’s output shrank by 1.2 mbpd. Thus, Iranian crude production could well decline to 2.6 mbpd in the fourth quarter.
If this situation emerges OPEC producers will have to increase their production by close to 1.4 mbpd in the fourth quarter. The cartel’s spare capacity (excluding Iran) is around 2.5mbpd, and if OPEC increases production to keep the oil market well supplied, its spare capacity will be squeezed to close to 1mbpd in the fourth quarter. This will make the market susceptible to any supply outages in major oil producing countries such as Libya and Nigeria. As such, the threat to supply is likely to keep oil prices elevated in the fourth quarter. In this scenario we expect tight supply and backwardation in prices to lead to further inventory drawdown in the fourth quarter. Consequently, seasonal gains in oil trade and tanker rates could well be limited this winter.