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Oil bear market shines light on US shale capability

12:30 pm, 9th November 2018

The price of oil, as measured by its US benchmark, has entered bear market territory – in other words, a fall of 20% or more from its peak – in barely a month.

A barrel of US light crude oil, which hit a near four-year high of $76.41 on 3 October, was today trading as low as $60.06, representing a drop of 21%.

Brent crude, the European benchmark, is not quite there yet: it reached a peak of $86.29 on the same day and, earlier today, was trading at $69.99 at one point, representing a fall of just under 19%.

But it would be no surprise to see it extend those falls into bear market territory.

There are a number of reasons why oil has sold off as rapidly as it has.

One is that, although US sanctions against Iranian oil exports finally kicked in earlier this week, the impact of those sanctions has been mitigated by the Trump administration’s decision to grant “waivers” to eight countries – China, India, Turkey, South Korea, Japan, Italy, Greece and Taiwan – allowing them to continue importing at least some Iranian oil for the next six months.

Those eight countries are Iran’s biggest customers and account for around three-quarters of the Islamic Republic’s oil exports.

Iran will not export as much crude as it has been. For example, China, its biggest single customer, is expected to buy around 360,000 barrels per day during the first 180-day waiver period.

That is around half of what it has been buying daily from Tehran, on average, since the beginning of 2016.

And India, which is Iran’s second largest customer, is expected to continue importing around 300,000 barrels per day, representing up to two-thirds of what it buys on an average daily basis.

So the global oil market is not going to be hit by a shortage of supplies from Iran just yet and, moreover, further waivers are expected to be issued once the initial 180 day waivers expire. And, in any case, any shortfall in supplies from Iran is likely to be more than covered by supplies from elsewhere.

The second factor is that, thanks to the shale revolution, US supplies are growing rapidly.

America has already overtaken Russia and Saudi Arabia to become the world’s largest producer and figures from the US Energy Information Administration (EIA) suggest it was averaging 11.6 million barrels per day last week.

US crude stockpiles have increased for seven consecutive weeks and those are likely to be added to.

The EIA is predicting that output will reach 12.1 million barrels per day in the new year. To put that in context, the BP Statistical Review of World Energy 2018 puts global daily crude production at 92.6 million barrels per day for last year, so the increase is meaningful.

But it is not only the United States that has meaningfully raised oil production in recent weeks.

For the first time, just three producers – the US, Russia and Saudi Arabia – now account for a third of global oil production and both the latter two have, like the US, been increasing production.

Russian output in October is put at a record 11.4 million barrels per day – an increase of nearly half a million barrels per day since it began ramping up production levels in May.

And Saudi production has recently been averaging a record 10.7 million barrels per day. Russia and the Saudis have pledged to increase production to more than make up for any lost Iranian supplies. Other producers, including Brazil and Iraq, have also boosted their production levels during the last six months.

So the supply story is robust. All of this has come as something of a surprise to the market which, in late September and early October, was more focused on a loss of supplies from Iran due to sanctions and also on weaker supplies from Marxist Venezuela due to the collapse of its economy.

On the other side of the equation, there is an expectation that crude demand may be starting to soften, reflecting weaker prospects for the world economy.

The International Monetary Fund last month cut its forecasts for global GDP growth from 3.9% both this year and next year to just 3.7%.

That is likely to play out in the form of weaker demand for oil. The key driver of this, in the short term, is the trade war between the US and China.

That has not started yet: indeed, during October, Chinese crude imports hit an all-time high amid indications that the country’s manufacturers were stepping up production ahead of US tariffs kicking in. Demand is also slowing from emerging markets due to the strength of the dollar.

The market is assuming that, in the short term, prices will carry on falling.

The Brent crude futures contract for January currently points to prices being lower than in February, implying some producers currently believe that, with the market oversupplied, it is more worth their while to store oil, rather than sell it.

That may led to crude stockpiles, as has been seen in the US, growing further.

The bigger long term picture is that the United States has displaced Saudi Arabia as the world’s most important ‘swing’ producer of oil.

The Saudis have, since the 1970s, been able to exert disproportionate influence on global oil prices by – along with other Opec producers – cutting production at various times.

The Americans have shown this year that they are capable of ramping up production by more than the Saudis can cut it.

That will have profound implications not just for oil prices but, ultimately, geopolitics.