The Fuse

Supply Risks Mount Even as Oil Market Sees Balance

by Nick Cunningham | May 01, 2019

Global oil production outages are beginning to pile up, clouding the supply outlook for the months ahead.

The uprising in Venezuela threatens to accelerate production declines. The U.S. decision to eliminate sanctions waivers on buying oil from Iran puts roughly 1.3 million barrels per day (Mbd) at risk, while fighting in Libya is another land mine for oil supply that could yet explode. There are conflicting data points on the supply picture right now, but taken together, the outages put the market at risk.

Outages mount
The April 22 announcement by the U.S. State Department that it would not allow additional waivers on Iran sanctions was met by a spike in oil prices. The policy decision immediately puts 1.3 Mbd of Iranian oil exports into doubt. However, in the days since that announcement, fears of the worst-case outcome for Iran have eased. There is still some ability for Iran to export oil, either clandestinely or through swap agreements with other countries. China and India in particular appear unlikely to zero out purchases. “We believe that many oil traders think that the waiver policy could yet become less hawkish, and that most traders expect a significant flow of Iranian exports to continue,” Standard Chartered wrote in an April 30 note. Nevertheless, even if Iran’s 1.3 Mbd of exports won’t fall to zero, shipments are widely expected to decline significantly.

If the Libyan National Army becomes overstretched, its ability to guarantee security at oil fields and export terminals will be hampered.

Libya is also an ongoing source of supply risk. The Libyan National Army (LNA) led by General Khalifa Haftar is still attacking Tripoli. While there has been little evidence of a disruption to oil operations, the longer the conflict persists, the more likely the country will suffer disruptions. If the LNA becomes overstretched, its ability to guarantee security at oil fields and export terminals will be hampered. Adding to the confusion, the Trump administration has sent conflicting signals on official U.S. policy. The State Department criticized the LNA’s attack on Tripoli at first and called on Haftar to halt his campaign, but more recently, the administration has lent support for his assault. The confusion increases the odds that the battle descends into protracted civil war, which only adds to the risk to Libya’s oil supply.

The most recent geopolitical flashpoint is in Venezuela, where an uprising by opposition leader Juan Guaidó and at least some elements of the military have sought to overthrow President Nicolas Maduro. At the time of this writing, the uprising failed to dislodge Maduro. Although faced with a setback, mass protests continue. Venezuela has already suffered catastrophic oil production declines, with output descending to just 732,000 barrels per day (b/d) in March, down 289,000 b/d from a month earlier. Crippling electricity shortages accelerated the losses in March and remain a significant problem. Production is now roughly at half of the 1.35 Mbd average from last year. The losses are expected to continue, and, as is the case with Libya, a drawn out civil war only increases the odds of deeper disruptions.

The cumulative effect of supply losses from Iran, Libya and Venezuela could push the oil market into a significant supply deficit, sending oil prices up. “That the White House is tightening supply [on Iran] just as we enter the summer driving season, a typical high point for gasoline demand, further amplifies potential price movements, and additional supply risks in Venezuela and Libya could make for an extremely tight market,” Scotiabank said in a recent report.

Ample supply or a deficit?
Despite the supply risks, for now at least, the data is mixed. According to Standard Chartered, the oil market was roughly balanced in February before slipping into a 480,000-b/d supply deficit in March. But it may have rebounded to a state of equilibrium again in April. Inventories have drained but the tenuous balance is contingent upon OPEC+ keeping supply off of the market. Any production increase from OPEC+ would likely lead to a renewed surplus unless the increase merely offsets outages in Iran, Venezuela or Libya.

“Further, should OPEC wish to bring global inventories lower, those replacements would need to be less than barrel-for-barrel,” Standard Chartered wrote in a note. Against this backdrop, there is a “strong impetus” towards an extension of the OPEC+ supply agreement. Saudi oil minister Khalid al-Falih hinted at as much in recent comments to Russian press, suggesting an extension might be needed through the end of the year.

Recently released data from the U.S. also paints a mixed picture. The U.S. saw overall oil production fall in February by 187,000 b/d to 11.683 Mbd, the second consecutive month of declines. The dip is clear evidence that the U.S. shale industry pulled back in response to the meltdown in prices in the fourth quarter. More recent, though less reliable, weekly surveys put U.S. production at 12.3 Mbd in late April.  While the discrepancy will be reconciled over time, even the higher weekly figures have slowed substantially in recent months, another indication of a slowdown.

However, the EIA continues to report very large increases in crude oil inventories. For the week ending on April 26, U.S. inventories soared by 10 million barrels, and are up 20 million barrels in the past month. The rapid increase in crude stocks undercuts the notion that the oil market is suffering from a significant deficit.

Between Iran, Libya and Venezuela, the seeds of a major disruption to the oil market have already been sown.

Between Iran, Libya and Venezuela, the seeds of a major disruption to the oil market have already been sown. A significant outage in one could push the market into deficit. A decline in two, or even all three of them, would pose a much greater challenge.

But, for now, the market is getting by. With oil prices falling back from recent highs, the pressure on OPEC+ to unwind their production agreement is easing.