Fundamentals is our monthly review of global oil data, this is the July edition.
Thanks to rising GCC and Russian production before Iranian exports have actually dropped off, the market has to now contend with nearly 1 mb/d more supply than it had previously expected, and this (coupled with abysmal demand readings from Brazil and Saudi Arabia) is why our Q2 18 stockdraws have been reduced to flat and Q3 18 draws are now 0.3 mb/d compared to the initial expectations of 0.7 mb/d forecasted at the start of the year.
It is the miss in Q3 18 balances that matters the most. Q1 18 stockbuilds were slightly less than we expected (0.1 mb/d vs 0.5 mb/d forecasted in January) and Q2 18 turned into small draws (50 thousand b/d draw vs 0.4 mb/d draw expected at the start of the year), but these misses were within the margin of error in a 100 mb/d market and, on average, H1 18 balances ended up being broadly as expected, with a flat stock profile. The biggest reason for missing the Q2 18 stockdraw is exactly the reason why Q3 18 draws will end up being far more benign—Trump’s decision to impose sanctions on Iran and a deal made with the Saudis that they would pre-empt the loss from Iran by increasing production from May onwards to keep a lid on gasoline prices ahead of the 4 November midterm elections. The point is that not only were the H1 18 misses small, they mattered less than the Q3 18 change simply because of the universal belief that summer draws would be enormous, which is what led to the length in positioning. So, some of the recent moves in timespreads are therefore not just a function of prompt oversupply, but also about weaker fundamentals relative to expectations.
The June/July crude balances—which were supposed to set up for substantial summer draws—have ended up being sloppy even though June crude draws were large. The problem, however, is that the draws occurred in regions least expected. Preliminary OECD crude stockdraws for June were over 25 mb, and even though we expect this figure to be revised lower, the market is pricing oil as if there was no draw whatsoever. Over 70% of the June crude draw was in the US, where crude differentials have reacted positively. No one, ourselves included, expected US crude stocks to draw and the rest of the world to build—the opposite was expected. But steep backwardation and high flat prices meant the US exported every barrel possible, tightening its local balance but weighing on Europe, where crude stocks have risen by 12 mb since the start of the year. Stocks have also drawn in China, with the nearly 30 mb Shandong overhang almost disappearing and commercial inventories also falling sharply in July. But because China has only just started to buy alternative crudes, these draws have not yet translated to tighter crude markets. Moreover, the draws have clearly not been in light sweet crudes. In other words, the global crude market is not as oversupplied as BFOE balances (and hence Brent) would suggest.
Still, we strongly believe that without the Iran sanctions and Saudi backstop, our original Q3 18 projections of around 0.7 mb/d stockdraw would have been fairly accurate as the GCC and Russia would not have raised output from May. Instead, they would have gradually increased production in H2 18 as the market got tighter, which is what we had baked into our balances. While we were of the view that Trump was likely to pull out of the JCPOA, there was little to suggest that he would push for zero Iranian exports. Similarly now, while we believe that the Trump administration is unlikely to issue blanket waivers and is very serious about trying to cut off all Iranian oil sales, there is no guarantee that Trump won’t change his mind if the political winds change. Even so, uncertainty around what China does with regards to Iranian purchases is enough to sow seeds of doubts about forward balances, especially as many have been badly burnt. After all, China could increase imports from Iran substantially and offset much of the losses from other countries. While this is definitely not our view, it is undoubtedly the prevalent view in the market right now. This makes forming a concrete view on Q4 18 balances challenging.
However, we believe that despite the growing risks of a trade war denting economic growth, oil demand will be fine for now and Iranian exports will fall sharply from September onwards implying we remain confident in our Q4 18 balances. But with threats of an imminent SPR release still doing the rounds, the market is better off waiting for more attractive entry points to position for Q4 18. Refinery buying is also being guided by the same thoughts. With refinery maintenance around the corner and SPR release probable, the market is choosing to take a wait-and-see approach rather than being in a rush to purchase crude.