Thursday, August 25, 2016

Does Iranian Oil Still Matter?

With a crude oil rallying looking to end out a hot summer, investors will be focused on OPEC supply reactions that will develop over the next couple of months. At the end of last week, WTI contracts are trading up 9.16 percent over the past month posting a year-to-date gain of 11.04 percent, and Brent contracts are up 9.55 percent and 14.58 percent respectively. Worries that a glut still remains have subsided, and instead, investors have piled behind a rally off of all-time lows that were seen at the beginning of the year. Now, eyes are on producers to see how they will react to the higher prices.

The rally came after seven strong bullish trading sessions that were supported by reports of an OPEC output freeze in consideration and a surprise 2.5 million barrel draw on inventory last week. Prices jumped from lows near the $40's into territory well above both the 50-day and 200-day moving averages. Volume was not as strong, but the clear direction of the trend did not lack conviction. We're now at a bit of a resistance where bullish traders have backed off, and the bears have taken control. With relatively bland data coming from North American producers, investors should keep their eyes on production totals from their counterparts in the Middle East. Bolstered by a slightly mitigated glut, OPEC members from that region have continued to pump at higher levels hoping that an increase in fossil fuel consumption will make up the supply difference. Although, reports of a September output freeze in the cards has done enough to convolute the fundamental picture and any rational sentiment. The spotlight will, once again, be pointed towards OPEC's swing producers, Iran and Saudi Arabia, two nations which couldn't put aside their geopolitical difference to arrive at an agreement. In just under a month, the biggest oil producers in the world will come to the table once again, and the hopes for a freeze reside in the unstable relationship between Iran and Saudi Arabia.


The question that most people have going into the September meeting is whether Iran has enough pull to influence the proceedings. There's no doubt that Saudi Arabia remains in the saddle, but the Iranians have the most availability capacity as they continue to rebound from the sanctions that were just lifted at the beginning of the year. Since then, monthly production figures have grown almost 300,000 b/d which makes Iran's output the fastest growing in OPEC. This fact made an output freeze in April all but impossible despite Saudi Arabia's desires to come to an agreement. With Iranian production returning to pre-sanction levels, the nation's available capacity has shrunk. Thus, volatility in output figures should fall in tandem, making an output freeze deal more likely if other OPEC members can cooperate. Countries like Nigeria and Venezuela might show more resistance as their governments, like Iran's, are strapped for revenue and slightly higher oil prices would relieve some financial pressure if the output, at the very least, remained stable. But that shouldn't dim the outlook much, in the end, Saudi Arabia has most of the power. However, Iran will once again be in the spotlight as its fundamental position is brought into the foreground. Investors need to pay attention to updates on its oil output there in preparation for the upcoming OPEC meeting.

Unfortunately, statements from the Iranian government have suggested a dim outlook for the September meeting. The Wall Street Journal reported that Iran said "it doesn’t expect that its production will have risen to the levels the country" and "it needs to justify cooperation with its rivals." Officials say that production would have to breach the 4 million barrel a day level for they would consider cooperation. In reality, this output goal does not appear to be achievable in the near-term, and definitely not by September. Naturally, an output freeze should be counted out, but Saudi Arabia's sway should never be counted out. If a freeze is a necessity, the combined power of OPEC members without Iran would have enough production to influence the global markets. But in allowing Iran to successfully resist, the cartel is endangering its own existence through moral hazard. Nations in monetary distress would feel hard done by and be quick to nominate themselves for an exception. Estimates from OilPrice.com suggest that Iran would need $70 billion in foreign capital to increase its production to its 2021 target of 4.8 million b/d. In the end, Iran's target bring low, steady growth in the long run, a plan that wouldn't be significantly interrupted with a short-term output freeze.

News of oil swaps between Iranian and Russian energy companies might also be disturbing to OPEC going into September. As the largest oil and gas producer in the world, Russia has the potential to undermine any production moves made by the oil cartel. According to Mehr News, the swaps could include a capacity of up to 150,000 barrels a day with the opportunity to increase natural gas trade by a third as well. The Iranian government implemented these plans in order to rehabilitate energy exports which had fallen during a period of trade sanctions. In the first five months of 2016, Iran's exports have grown by 1.4 million barrels a day with hopes of growing above 3.0 million barrels a day in the coming months. Growing exports don't necessarily mean more production, but it certainly means more oil, whether stored or pumped, will reach the markets. A joint deal with Russia will put pressure on other OPEC members to secure their own buyers. Market share has definitely become a real issue as China's growth begins to level off and U.S. oil is allowed to be exported. These concerns will be in the mind of minor and major OPEC members alike and might have enough sway to diminish hope of a freeze.

Iran's recent policy changes and production trends don't bode well for an output freeze in September which will be bearish for oil through the end of the year. North American production has started to stabilize to a less volatile equilibrium point which might do little to move energy futures in the latter half of the year. In fact, OPEC's meeting in September might be the last event for a major crude oil trend shift before the election in November. Speculation before the meeting next month will most likely boost oil, but investors shouldn't be fooled by this peak. If fundamentals are stable, oil will remain in the $40's through December barring any "black swan" event.


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