In theory, failure to recertify could remove hundreds of thousands of barrels of crude from the market and cause a significant tightening of the supply-demand balance. For the time being, however, the Trump administration’s increasingly hawkish position on Iran has not been enough to offset the impact of increasing supply from shale. Crude traders may be under-estimating the president’s determination to end what he has termed a “terrible” deal and ratchet up the pressure on Iran. But the president and his new secretary of state, assuming the nominee is confirmed by the US Senate, will still face the same diplomatic constraints in ending the deal and renewing the boycott of Iranian oil.
European countries, including Britain, France and Germany, are no more eager than before to abandon the nuclear deal or re-impose broad economic sanctions. Russia is also unlikely to co-operate since relations and cooperation with the US are at the lowest ebb since the end of the Cold War. And the US has embarked on a trade war with China, which is further complicating a relationship already beset by multiple other disputes. In the circumstances, traders may have concluded even a failure to recertify the deal will not lead to the removal of a significant amount of crude from the market.
They may also have concluded any loss of crude from Iran would be made up by increased production and exports from Saudi Arabia, Kuwait, the UAE, Iraq and Russia. Compliance with the Opec/non-Opec output curbs has left all these countries with actual or potential spare capacity to increase production to offset any loss from Iran. Corporate tax cuts approved by the US Congress and the president at the end of 2017 have been broadly welcomed by investors and the business community. Tax reductions for businesses and many individual taxpayers should increase the economy’s productive potential as well as stimulating short-term consumption and investment.
Overall, the tax reductions should have a positive impact on economic growth and oil consumption in the short term, which should be bullish for oil prices. But the medium term impact is more uncertain because tax reductions are boosting the economy at a time when the business cycle already appears relatively mature. The fiscal stimulus may be accelerating the final stages of the economic cycle and bringing forward the date of the next recession. The current expansion is already the third-longest on record and it will become the second-longest in May 2018 and the longest in July 2019.
The business and financial community has broadly welcomed the tax cuts even if it has doubts about other elements of the president’s programme. But the departure of the president’s chief economic adviser and the secretary of state have unsettled the same business leaders who have vocally supported the administration on tax. Most business leaders are opposed to the president’s more populist and nationalist policies even as they support his tax cutting. There is little enthusiasm among business leaders and investors for increased tariffs, tougher restrictions on investment and “de-globalisation”.
The administration’s more hawkish and nationalist turn in recent weeks may therefore be fuelling increased concern about the medium-term economic outlook with negative implications for oil demand and prices. Benchmark crude oil prices and calendar spreads have been softening slowly but steadily for the last two months. Global oil consumption is growing rapidly and inventories have fallen, but supply is now expected to increase by more than 2mn bpd in 2018. Production from the US shale fields is surging in response to the increase in prices and drilling since the middle of last year.
Coupled with extra oil from Canada, Brazil and Norway, production should be more than enough to meet the rise in demand in 2018. Brent spot prices and calendar spreads had been rallying strongly since the end of June 2017 in the expectation the market would move into a sustained supply deficit. But the surge in shale production has made that much less likely and traders have started to revise their expectations for a deficit in the second half of the year. The shift has flowed through into spot prices and more importantly into spreads, which track the supply-demand balance closely. Brent spot prices and spreads have essentially shown no net increase since the middle of December as the earlier rally has stalled.
For the moment, traders see the enormous increase in non-Opec oil supply this year outweighing any threat from the failure to recertify the Iran deal in May. Hedge fund managers had accumulated a record bullish position in futures and options contracts linked to the price of crude and refined fuels by the middle of January. Some of those positions amounting to around 250mn barrels have been gradually liquidated over the last six weeks, which has kept oil prices under pressure. But hedge funds and other money managers still hold an overall bullish position in crude and fuels amounting to more than 1.2bn barrels. Bullish positions outnumber bearish ones by a ratio of 10:1. With so many bullish positions overhanging the market, it is proving hard for prices to rally, despite the Trump administration’s increasingly hard-line position on Iran.
Sources and photo credits: Gulf Time with assistance by By John Kemp/London