Crude Oil Trade: There's something about the oil price

More and more banks and other institutions are publishing forecasts suggesting that the oil price could increase during the next couple of months, with some expecting Brent to stabilise closer to USD 80 per barrel, while others expect the rapidly tightening supply, primarily driven by OPEC+ cuts, to potentially push prices even higher, with USD 100 per barrel on the horizon.

The collapse of Iran and Venezuela is a probable scenario now, as the market expects the US to become even tougher, in an effort to completely eliminate any flows from the two producers in the near future. The outages expected in parallel to the anticipated slowdown in US shale production could prove enough for these forecasts to materialise.

Meanwhile, IMO 2020 regulations could further strengthen the trend developing, as global inventories are expected to decline in parallel to the tightening market. The conditions are very similar to what happened a decade ago, when the world ran out of diesel refining capacity in 2007/2008. Back then Saudi Arabia increased its heavy crude oil production to meet global demand, with spreads between diesel and bunker fuels reaching new highs, exactly as differentials between light and heavy crude did. The transition for shipowners from high sulphur into ultra-low sulphur bunker fuel due to the IMO 2020 regulation is expected to create similar conditions. The impact might be less dramatic though, as refining capacity is set to increase by 1.1 million barrels per day (bpd) this year, with a great amount of the current capacity not utilised completely. Apart from that, several producers seem to be ready to increase their output if required and if geopolitical conditions allow them to. Quick examples include the US and any country participating in the OPEC+ agreement.

As shipowners switch from heavy fuel oils and start burning low-sulphur fuels, including distillates, distillate demand is set to expand. This is expected to support higher crude oil prices due to refiners turning more crude oil into distillates and primarily interested in light grades, as around 60% of these volumes can be turned into distillate with the right refining toolkit.

As a result, most forecasts now expect oil prices to further increase this year, but meanwhile most of them simply ignore that global demand will need to adjust to the new price of the commodity. This could be a risk, especially if some of the biggest economies suffer a significant economic slowdown. Other scenarios that could have a similar impact include the OPEC+ agreement not lasting long, if some producers abandon the cuts, as happened last year. Meanwhile, the higher oil prices could be threatened if the US extends waivers on Iranian sanctions. There is scepticism about the power the US has, as the big question is whether US shale could fully replace any shortage created after Iran and Venezuela's collapse. US production still needs to face capital discipline as well. Without time, any transition will take time as the industry cannot quickly get prepared for the changes expected.

Focusing on demand, the higher oil prices should have an impact in the near term as more pressure is added against demand growth. Globally, additions are still expected to reach 1.4 million bpd this year, but concern has started developing on what will follow if oil prices approach USD 80 per barrel. Prices above USD 70 per barrel are already expected to cause changes in consumption across several emerging markets, including main drivers of global demand growth, China and India. But even consumption in countries like the US will have to adjust.

In terms of oil on water, data made available in IHS Markit's Commodities at Sea suggests volumes have been moving closer to one billion barrels, around 10% less than the volumes observed in late 2018 early 2019. Seasonality is expected to push these numbers even lower, potentially below one billion barrels as we approach the summer period for the northern hemisphere. April has been volatile in terms of volumes loaded and discharged with significant changes to report for the net number, which typically has an impact on vessel availability around the world, driving short-lasting ups and downs in the freight market.

Posted 25 April 2019 by Fotios Katsoulas, Associate Director, Lead Analyst Tanker Shipping & Alternative Fuels, S&P Global Commodity Insights