Crude oil to extend gains as West Asia boils over escalating US-Iran tensions

The New Year started with a bang as recent developments in West Asia (the Mid-East) pushed crude-oil prices sharply higher. Tension between the U.S. and Iran escalated after American forces killed Iran?s top commander, General Qassim Soleimani, in a drone strike in Baghdad. Iran then fired more than a dozen ballistic missiles against at least two Iraqi facilities hosting US-led coalition personnel. The latest events have renewed fears of war between the two countries. Because of this, the U.S. has deployed an additional 3,500 troops to West Asia. Iran declared it would no longer abide by any restriction imposed by the 2015 nuclear deal. It would no longer limit its capacity for uranium enrichment, the level of enrichment, the stock of enriched material, or research and development. However, its foreign minister said it does not want to escalate the present situation. Any escalation of tension between US and Iran may have huge ramification on crude-oil prices.

On the other hand, Iraq is already in the midst of a tumultuous period. Since October, more than 450 people have been killed in mass protests criticizing the country’s poor quality of life and demanding new electoral laws and accountability for corruption. Many have condemned foreign influence and demanded an end to the system imposed since the U.S.-led invasion in 2003, the ouster of the country’s ruling elite and placement of an independent in the prime minister’s seat. Protestors have said that if their demands are not met they will target Iraq?s oil facilities. Iraq?s prime minister and president resigned due to public pressure. Hence geo-political tension in West Asia is a matter of concern.

Last month, OPEC and non-OPEC agreed to cut production by 1.7 million barrels a day till March 2020. Saudi Arabia’s Energy Minister, Prince Abdulaziz bin Salman, said that his country would extend a voluntary cut of 400,000 b/d. This indirectly means that OPEC’s cuts would effectively amount to 2.1 million b/d. This additional adjustment has been effective from 1st January 2020. However, the IEA has warned that global crude-oil inventories could still rise sharply despite OPEC and its allies deepening their output cuts amid slowing U.S. production growth. The IEA has estimated that global oil inventories could build by 700,000 b/d in the first quarter of 2020. Even if OPEC and non-OPEC adhere strictly to their new pact and political troubles continued to hobble exports from Iran, Libya and Venezuela, the IEA said that only 530,000 b/d of crude would be withdrawn from the market compared to production in November. OPEC will hold an extraordinary meeting in Vienna on 5th March 2020 to review the energy market and the implementation of the production-cut agreement.

Due to production restraints by most OPEC members, continuing sanctions on Iran and the ongoing declines in Venezuela?s crude-oil production, the EIA expects OPEC production in 2020 to fall. The EIA forecasts OPEC crude-oil production to average 29.3 million b/d in 2020, down 0.5 million b/d from 2019. The IEA lowered its forecast of supply growth by non-OPEC countries in 2020, by 200,000 b/d, due to the continuing slowdown in the U.S., reduced expectations for Brazil and Ghana as well as additional cuts by OPEC’s allies. The biggest reduction is expected to be in U.S. shale-oil output, where operators have been cutting spending under investor pressure to improve returns. The IEA estimates total U.S. oil -production growth to slow to 1.1 million b/d in 2020, from 1.6 million in 2019.

In 2020, global oil demand is expected to grow by 1.08 million b/d, with the OECD growing 0.07 million b/d. In the non-OECD region, oil-demand growth is projected at around 1.01 million b/d, with growth projected to improve in Other Asia, Latin America and West Asia. In 2020, oil demand in China is projected to slow further, compared to last year, largely in line with lower economic projections, compared to 2019. The U.S. and China have agreed on a limited trade deal and Trump said that the deal would be signed by 15th January. Hence markets are awaiting more details. Overall, the short-term outlook for crude oil is bullish with more focus on geo-political developments in the Middle East.

(Rushabh Maru is a Research Analyst, Currency and Commodity, Anand Rathi Shares and Stock Brokers. Views expressed are the author’s own)