The oil market is being buffeted by uncertainties on the demand side, notably from China, and questions about sanctions enforcement on the supply side. The big drivers continue to be OPEC+ cuts, which are offsetting some gains from those countries not bound by cuts both in and outside OPEC+. We continue to expect, along with market actors, that OPEC+ cuts will be rolled over, few barrels will be cut because of sanctions enforcement, and that sluggish but continued growth will keep interest rates and debt service relatively high. Overall, expect some of these 5-7% swings to continue as OPEC+ related continued inventory drawdowns are offset by sluggish demand growth. To break out of this range would require significant output losses, with the market eyes most focused on Iran.
A few key moving pieces.
Sanctions interplay. We do not expect meaningful changes in enforcement of Iran and Russia sanctions in the near-term, which could keep volumes relatively steady.
- The Biden administration has begun enforcement actions on Russian price cap but measures so far are limited and unlikely to deter non-G7 service providers. The shift away from G7 service providers and self-insurance will continue. Chinese consumption capacity and India’s ability to pay will be more important drivers of demand. We assume only modest sales decline, with crude oil outpacing products.
- As for Iran, there is considerable political pressure to increase sanctions enforcement, but this is hard to implement given the black market nature of the trade. Some additional listings of tankers may follow, perhaps capping exports near current levels. Iran is likely near its immediate capacity, but we think that enforcement actions will be focused more on Russian-Iranian military links rather than oil flows. Chinese purchases do seem to be softening however. Additional mandated sanctions may follow especially if the Israel Hamas war regionalizes further but US government priorities are more on providing aid to Israel and Ukraine than on sanctions enforcement.
- Small volumes of additional supply from Venezuela are likely as entrenched players like Chevron are able to utilize some existing spare capacity. Significant new investment will be limited by the temporary nature of the sanctions relief, the outstanding debt web of arrears faced by the government which restricts market access and the uncertainties associated in the new electoral framework. Significant new investment will likely wait until after the election. However, the ability to sell at market prices rather than barter to the Chinese (and implicitly to the Americans) as well as the return of some risk-sensitive oil service providers will keep Venezuela a net addition to global markets.
There are other steady production increases from elsewhere in the Americas which are partly offsetting the incremental losses from OPEC+ these will not stop the fundamental tightening of the oil market in the next few months, but seasonal trends will contribute to easing.
Chinese demand has held up, in part due to refiling floating storage and greater use of oil products for power generation due to hydro shortages. There is evidence that this increase in storage reflects the overall sluggish demand in the economy, which is likely to persist into 2024. China remains a price setter for many producers, not least Russia and Iran, and it will continue to balance its different suppliers in West Asia.
The current oil price has not prompted meaningful demand destruction but further increases could do so, especially in countries which have suffered under weaker domestic currencies versus the USD and which bear the brunt of higher transit costs. This potential demand destruction is one reason we do not expect oil prices to remain above $100 even if they reach that level. Higher debt service costs will be a drag on growth with no immediate likelihood of an outright recession in the coming months.
Ziemba Insights 