Oil prices opened trade this week with a decline on reports that a deal between the U.S. and Iran was imminent. Brent crude slipped below $100 for the first time in days. But then President Trump said there was no rush on a deal and the U.S blockade in Hormuz would remain. While traders scratch their heads, analysts are warning that crude could remain well above $100 per barrel for years. This is literally uncharted territory for oil.
Negotiations with Iran were “proceeding in an orderly and constructive manner,” the U.S. president told media over the weekend, fueling optimism that has actually been a feature of oil markets ever since the Iranian army closed the Strait of Hormuz in response to the U.S. and Israeli missile attacks on the country. Despite the supply crunch that the closure caused, traders remained remarkably certain that it would not last more than a few days, possibly a couple of weeks. Three months in, this optimism remains.
Indeed, oil traders have been boosting their short positions on crude for no less than seven weeks in a row in anticipation of an end to the crisis that has removed some 14 million barrels from the world’s daily oil supply. According to John Kemp, bearish positions in Brent crude had gone up to 100 million barrels by May 19, from 40 million barrels at the end of March. Meanwhile, the blocked waterway remains almost unused and the ripple effect is spreading. Related: Why Hasn’t Oil Hit $150?
Rapidly falling inventories, missing Middle Eastern exports, and rising summer demand could push global oil markets into dangerous territory by July or August, the head of the International Energy Agency warned earlier this month.
“This may be difficult and we may be entering the red zone in July-August if we don’t see some improvements,” Fatih Birol said. Unlike some earlier warnings that sounded more like a theoretical note, the inventory data increasingly suggest that Birol may actually have a point.
The secretary-general of the IEA said oil stocks are being steadily eroded while “no new oil was coming from the Middle East” just as demand begins climbing into peak travel season. No oil from the Middle East is the bigger and more immediate part of the problem—but there is another one, and that part is the years of subdued investment in new oil supply on a global level.
Investment in the oil and gas industry has been weak for about a decade, since the U.S. shale boom from the 2010, natural resource analysts and investors Leigh Goehring and Adam Rozencwajg wrote in their latest quarterly commentary. As a result, global production has been largely stalling in terms of growth pace everywhere except in the U.S. shale patch, where growth is slowing down as well. Now, with the Strait of Hormuz closed, the world is in an unprecedented situation of supply tightness.
“The market has never before attempted to function for an extended period with such a large
volume impaired simultaneously,” Goehring and Rozencwajg wrote, adding that “The industry appears to have entered another structurally tight phase following years of inadequate capital spending, just as the market confronts an acute physical bottleneck of historic proportions.”
The experts suggested that if the blockade in the Strait of Hormuz extended further in time, $120 to $150 would become the new normal for Brent crude over the next few years—once market players realize the extent of the supply problem, presumably, because right now, this is being grossly underestimated.
“At least 15 million barrels per day of supply appears to be directly curtailed. On volume alone, the disruption exceeds every previous oil crisis. Yet dated Brent — still the best measure of physical delivered crude — managed at its peak to exceed its 2008 high by only $4 per barrel,” Goehring and Rozencwajg pointed out, going on to add that “The market, in other words, has been presented with an energy dislocation larger than any previously recorded and has responded as though it were a difficult but ultimately temporary inconvenience.”
The moment this perception is shattered by physical markets would likely be the moment when oil prices make up for lost time, as it were, soaring higher and staying there, unless, of course, that notorious deal that Trump is negotiating with Tehran actually materializes.
Yet even with a deal and a reopened Hormuz, the global energy system is in danger of a breakdown due to the sheer scale of the supply crunch, which Goehring and Rozencwajg estimate at as much as 15 million barrels daily. Bringing back this amount of daily production online takes time. And if a deal does not materialize soon, traders may begin to lose their optimism as the effects of the crisis in the physical market become more pronounced.
“Oil moves slowly through the global system,” Goehring and Rozencwajg wrote. “So does information. In both cases, the true condition of the market often reveals itself only after the underlying imbalance has become considerably more serious than first believed.”
By Irina Slav for Oilprice.com
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