The global crude oil market is reacting to the geopolitical uncertainty of further U.S. sanctions on Iran with a spike in prices. Brent crude, which has rallied almost $10/barrel since mid-August is currently at $80.80 a barrel. We think the recent rally is a market reaction rather than a major shift in supply/demand fundamentals. However, this reaction could drive prices close to $100 a barrel near term.
This comes at a point when President Trump has been blaming OPEC, though a tweet, for the recent rise in commodity prices. While Trump's tweets have nothing to do with the increase in crude oil prices, they do come with a "fear factor," something that Oman Oil Minister Mohammed Al Rumhy has called the "Washington Premium."
The fear is arising because of a big unknown today, whether Saudi Arabia and Russia can react fast enough to cuts in Iranian oil production because of the U.S. sanction? The market is evidently thinking not. So, tweets or not, the prices will be rising.
For a better sense of this question, we looked at what two of the largest crude oil trades in the world, Trafigura and Mercuria, are saying. The two companies actually buy, ship and sell the commodity around the world. They have access to color in the market like no other.
According to a commentary by Daniel Jaeggi, co-founder of Mercuria Energy Group Ltd., crude oil prices could surpass $100/b as the global oil market does not have the supply response for a potential disappearance of 2 million barrels a day in the fourth quarter. Jaeggi is projecting increased volatility towards year end due to the uncertainty around the duration and severity of the Iranian sanctions.
OPEC is not only dealing with the issue of Iran sanctions, but also looking into the dramatic drop of Venezuelan output. GlobalData forecast that Venezuelan crude oil production would fall to around one million barrels per day by the end of 2018. Crude oil production in Venezuela is practically falling at an average of 10% every quarter and has been since mid-2017.
The OPEC position today is one of "sit back and wait" as the U.S. carries out its Iran-sanctions agenda and buyers figure out where to source their crude oil from. Saudi Arabia, Russia and the United Arab Emirates have insisted that they have the spare capacity to satisfy the market's needs, but won't tap it right away.
According to commentaries by Ben Luckock, co-head of oil trading at Trafigura, when Trump announced plans last May to reimpose sanctions on Iran's oil exports, the market estimated a cut of about 300,000 to 700,000 barrels a day. However, the consensus has now moved to as much as 1.5 million barrels daily as the U.S. is "incredibly serious" about its measures.
Despite this bullish sentiment, crude oil at $100/barrel may be short lived as demand may be weakened by the U.S.-China trade war, which threatens economic growth in Asia. Turmoil in emerging countries could amplify the impact of higher prices on global demand growth. On the supply side, crude oil coming out of the U.S. is likely to put another lid on prices as scheduled pipelines come online by 2019-2020, reducing the existing glut in the Permian Basin we have today.
But for now, crude oil prices are going up, so enjoy the rally. For equity traders, there's no better way to express a long view on crude than long the United States Oil ETF (USO) , either outright long or via USO call options, the January 2019 $20 calls are the most traded today, indicating the direction the market is pointing.