Fundamentals is our monthly review of global oil data, this is the October edition.
Compared to September’s edition of Fundamentals, our H2 18 balances have weakened, primarily due to the significant upward revision to North American crude production. While Gulf of Mexico output has surprised to the upside, the revision to Canadian output is a baseline revision to bitumen supplies. While Canadian crude—however fast it grows—cannot get out of the country right now due to infrastructure constraints, from a supply-demand point of view, it still reduces the extent of Q3 18 draws, despite demand recovering in places like Russia. In fact, demand in oil-producing nations in the FSU, Latin America and the Middle East has started to recover just as oil prices have, even though Saudi Arabian demand remains wretched. While European demand and some emerging markets are showing signs of moderate weakness, oil exporters are picking up the baton, keeping global demand growth steady at around 1.4 mb/d.
The market primarily cares about Q4 18 balances. While our expected stockdraws have reduced from 1.2 mb/d last month to 0.9 mb/d, the crude tightness predicted is still largely intact despite higher OPEC output. In fact, higher Middle Eastern and Russian production should be baked into everyone’s balances for Q4 18 and should not come as a surprise. We maintain that Saudi exports will average around 7.8-7.9 mb/d across November and December after destocking from Japan, Egypt and the Kingdom are included, which is already in our balances. Exports in October so far, according to Kpler, are averaging 7.6 mb/d, broadly consistent with our expected 7.7 mb/d for the month. Iraqi exports from Basrah are holding around 3.6 mb/d with output around 4.55 mb/d, and we expect production to rise to 4.6 mb/d by year-end. UAE exports have leapt to 2.8 mb/d despite Ruwais ramping up runs, with the rise supported by the 0.1 mb/d SARB field starting in September and the 80 thousand b/d Umm Lulu Phase 2 starting up a month earlier than expected last week, although the uptick in combined volumes has only been 25 thousand b/d. So, we have raised our UAE output forecasts marginally higher for Q4 18, even though we maintain our view that Murban exports will have to fall off once the Ruwais refinery RFCC starts up.
And while the baseline for US production has been revised higher due to stronger GoM production, we see growth slowing sequentially. The frac market has taken a material turn for the worse during Q4 18 owing to a combination of infrastructure constraints and budgets being exhausted by producers. Indeed, we see m/m growth easing from 0.2 mb/d (January-July average) to broadly flat for the balance of the year and into 2019.
Ultimately, Q4 18’s fate depends on Iran. Exports in the month so far are still high at 1.6 mb/d, although this is biased towards the first 14 days, during which loadings were 2 mb/d. High Iranian exports were to be expected in the first half of October as plenty of buyers had stated that they wanted Iranian cargoes cleared at their ports before 4 November. But we maintain our view that Iranian exports are heading below 1 mb/d in November—the collapse was never meant to have occurred in October. Then there is the further complication of Iran having leased bonded storage in China in the Xingang area (Port of Dalian), where it is sending several tankers for storage, much like it did in 2012. Effectively, this allows Iran to produce 20 mb more than if it only had access to its domestic onshore and offshore storage, and it delays the need to reduce production by a couple of weeks. But this does not mean Chinese companies are buying more.
A drop in Iranian exports should ultimately support Brent spreads. But the barrage of US exports likely to land in Europe in December is weighing on subsequent Brent spreads beyond the prompt. Similarly, back-end buying is also flattening the curve. This is sending confusing signals to the market—with many doubting whether the physical market will ever tighten. The problem with Brent is a light sweet crude oversupply problem rather than about global balances. Trading Brent spreads will undoubtedly be a challenge with the growth of light sweet crude in the US. In some ways, the only way for Brent spreads to perform is if Brent-Dubai crunches in, as that will ensure a steady flow of crude from the North Sea to the east, which is where the barrels are needed. We have long been bullish sour crudes due to the expected drop in Iranian and ongoing fall in Venezuelan output, but we have also held the view that Brent-Dubai is unlikely to narrow, as investors in a bull market buy Brent to express their bullish views. Maybe this time, it is different.