Winter is on its way, and oil reserves are running tight.
Oil exports by Iran are down by nearly 30% since President Trump recently said that America would pull out from the nuclear deal between the two countries and impose sanctions again. The figure dropped to less than 2 million barrels per day in August and decreased even further in September. This created a build-up of tankers holding crude floating offshore.
In theory, there is enough surplus capacity between Russia and OPEC producers to offset the reduced Iranian supply, but theory and the reality of what can be produced in the next few weeks are not always the same.
If the possibility for additional production shortages in the rest of the world and a seasonal increase in the use of oil is taken into account, supply could lag behind demand within weeks. This might be enough to drive oil prices up.
No margin for error
The surplus capacities of OPEC members have already been reduced to less than 2 million barrels per day. The countries that were able to have already increased production in response to the recent decision are able to do away with individual production targets.
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Saudi Arabia could, in theory, raise production to 11.5 million barrels per day immediately as per a statement made by Crown Prince Mohammed bin Salman in April 2016. It has however never needed that size of production, and whether it’s able to do so has not been tested. It would probably need several months to reach that level, and this will require substantial drilling activity.
Number of rigs increases
Although the number of oil rigs in Saudi Arabia has steadily been increasing since April, it is now only where it was in 2017, when the country’s focus was on reducing rather than boosting output. Energy Aspects consultants Michal Meidan and Amrita Sen based in London said in September that even if Saudi Arabia began with the Khurais field expansion, it would probably ramp up to capacity very slowly. The field’s capacity is estimated at 0.3 million barrels per day.
After OPEC and its partners met in June, there was some talk of again starting production at the Neutral Zone fields, shared between Kuwait and Saudi Arabia, but little activity has been seen on the ground. The earliest production from those fields can realistically be expected only in Q1 of next year.
Russia has in the meantime increased its output by nearly 250,000 barrels per day since May. Alexander Novak, the country’s oil minister, says they could increase output by another 300,000 barrels. Russia will however only decide if the world needs extra oil after a meeting with OPEC partners in Algiers.
Q4 will almost be on us by then, and things could really get tight. Energy Aspects believes the world will need 33.5 million barrels per day from OPEC by then. According to a Bloomberg survey, OPEC supplies 32.7 million barrels per day at the moment. Nigeria, Libya, and Iraq are all producing nearly the highest volumes in years, but the security situation in these countries is deteriorating at the same time.
If unrest in the second city in Iraq spreads to oil fields close by, or there is a repeat of recent supply disruptions in any of these African countries, the shortfall could increase to more than a million barrels per day. The picture is worsened by Venezuelan production continuing to slide.
This is not even taking into account concerns about the outlook for oil demand being darkened by the impact of the US President’s trade wars and prospects for developing economies. Although these worries are legitimate, they will only be noticeable next year.
The direst issue is exports by Iran falling much faster than predicted by most analysts. A supply shortage could result in Brent being pushed far above $80 per barrel, the highest since late 2014.
We note that in Erlanger’s work the Energy Sector Erlanger Volume Swing (EVS) just turned to aggressive buy. So this might be a good time to buy some XLE calls or the ETF itself.