The always-volatile oil market is set for even more volatility over the next two years as investors and speculators try to make sense of the conflicting market forces determining the pace of demand growth and global oil supply.
Over the past month, the two key themes have been how much Iranian oil will come off the oil market from U.S. sanctions in November, and how much demand growth could suffer with the trade wars. More recently, another theme is the emerging markets turmoil following Turkey’s crisis. Throw in all the new and much stricter International Maritime Organization (IMO) regulations on sulfur fuel oil requirements from 2020 that are expected to upend the refining and shipping markets, and oil prices are set for wild swings, industry executives and analysts say.
The severe IMO restrictions on fuel oil’s sulfur content – aimed at reducing emissions – will drive increased demand for middle distillates such as diesel and marine gasoil, which in turn will push up demand for crude oil, Morgan Stanley analysts say. This would boost crude oil demand by additional 1.5 million bpd, potentially sending oil prices to $90 a barrel in 2020, according to Morgan Stanley.
But before the 2020 regulation, analysts and investors are closely watching two currently unfolding developments – the sanctions on Iran’s oil and possibly weakening global oil demand growth – the main bullish and bearish factors, respectively, in the market right now.
“With new sanctions coming into play and also the IMO 2020, we see there is more volatility and therefore more opportunities to trade. So, we see our customers taking, slowly but surely, positions for that to happen,” Eelco Hoekstra, chief executive at independent tank storage company Vopak, told CNBC on Friday.
Earlier this month, Tom Kloza, co-founder of the Oil Price Information Service, told CNBCthat prices could swing wildly, with a plunge to $50 and a spike above $100 not completely ruled out.
“If we had an oil [volatility index] it would be incredibly volatile” over the next year and a half, Kloza told CNBC.
The volume of Iran’s oil that sanctions would take out of the market is the biggest ‘known unknown’ on the supply side, with Venezuela’s plunging production and unstable Libyan exports already factored in in analysts’ estimates. But some experts believe that the Iran sanctions are yet to be fully priced in.
Earlier this month, Fitch Solutions said that the market is unprepared for the loss of Iranian oil, and that Iranian exports are “set for a ‘cliff edge exit’ from the market in Q418.” Under its core scenario, Fitch Solutions sees Iranian oil exports dropping by 1.3 million bpd by end-2019 with China expected to keep imports at around current levels; India and Turkey substantially reducing intake to qualify for waivers; and Europe, Japan, and South Korea cutting imports “to low or near-zero levels.”
“We are substantially above-consensus and our forecast implies Brent will average almost USD80.0/bbl over the rest of the year,” Fitch Solutions said.
ING, for its part, sees the global oil market “largely balanced over 4Q”, but this assumes that Iranian losses due to U.S. sanctions don’t exceed 500,000 bpd and Venezuelan production averages 1.2 million bpd in Q4.
However, ING commodities strategist Warren Patterson warned last week that the trade war and the higher risk in emerging markets have weighed on the price of oil, with Brent Crude prices dropping nearly 10 percent since late May.
“It does seem that the synchronised global growth story from earlier this year is losing some momentum,” Patterson said.
“Looking at individual cases suggests the potential impact on demand growth is limited, however when looked at in aggregate, the potential impact does start to look more significant,” the strategist noted.
The higher oil prices are already destroying gasoline demand in Brazil, for example, where motorists have the alternative to switch to ethanol, ING’s Patterson says. In Brazil, more than 50 percent of the light vehicle fleet consists of flex fuel vehicles that can run on gasoline or 100 percent ethanol. When ethanol becomes cheaper than gasoline, drivers switch to ethanol. In the first half of this year, gasoline sales dropped compared to the same period of 2017, while ethanol sales increased, said Patterson, adding that “This alternative option for motorists in Brazil has meant that we are actually seeing oil demand destruction in the country.”
Emerging markets currencies have weakened against the U.S. dollar in recent weeks – especially with the Turkish crisis – which could affect oil demand and depress oil prices. But the upcoming sanctions on Iran put an upward pressure on prices, with analysts currently only guesstimating how much oil would be removed from the market. The IMO rules throw in another unknown, so experts see wild swings in oil prices ahead.
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Author: Tyler Durden