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OIL TRADERS SANGUINE ABOUT RISKS FROM ISRAEL-IRAN CONFLICT: KEMP

By John Kemp
April 19, 20244:00 AM GMT+3Updated 8 months ago
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LONDON, April 18 (Reuters) - Petroleum prices have fallen following Iran's
missile and drone assault on Israel, confounding expectations that the
escalation of the shadow war would cause them to rise.
Like major industrial accidents, extreme moves in oil prices, spikes or slumps,
are always the product of multiple factors rather than a single cause.
Spikes usually occur when the business cycle is mature; inventories are well
below normal; spare production capacity is low; and there is an actual or
threatened disruption to production.
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In this instance, however, the escalation is occurring in a market that is
otherwise comfortably supplied, with inventories near the long-term average and
plenty of idle production capacity.
Traders have concluded Iran will not risk any disruption of its exports; the
United States will not risk significantly higher oil prices in an election year;
and the United States will restrain the next round of responses by Israel.
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As perceptions about the war risk have fallen, prices and calendar spreads have
retreated to pre-crisis levels, with the underlying fundamentals of production,
consumption and inventories reasserting themselves.


SHOCK ABSORBERS

Commercial inventories of crude oil and refined products across the advanced
economies in the Organisation for Economic Cooperation and Development (OECD)
were estimated at around 2,735 million barrels in March.

Commercial inventories were around 95 million barrels (-3% or -0.61 standard
deviations) below the prior 10-year seasonal average, based on an analysis of
data from the U.S. Energy Information Administration (EIA).
The deficit had increased from 51 million barrels (2% or -0.34 standard
deviations) in December 2023 but was only very slightly wider than a year ago
when it stood at 74 million barrels (-3% or -0.44 standard deviations).

The global market is tightening, but gradually, and inventories are still
relatively comfortable, able to absorb any short-term interruptions of
production.
Chartbook: Global oil inventories and prices, opens new tab
Saudi Arabia and other OPEC members in the Middle East were estimated to have
more than 4 million barrels per day of idled production capacity in March,
according to the EIA.
Unused capacity was at the highest level since the coronavirus pandemic in
2020-2021 and before that the recession following the financial crisis in
2009-2011.

With comfortable inventories and plenty of spare capacity, the market did not
appear primed for a large and sustained spike in prices.
Production outside OPEC⁺ is expected to grow strongly this year, especially in
the United States, Canada, Guyana and Brazil, sufficient to cover the increase
in consumption in 2024.
Strong production growth is likely to ensure that inventories remain reasonably
comfortable in all but the most extreme scenarios about conflict in the Middle
East.


PRICES AND SPREADS

Inflation-adjusted front-month Brent futures prices averaged $85 per barrel in
March, putting them almost exactly in line with the long-term average since
2000.
The futures market had already moved into an aggressive backwardation, with the
front-month contract trading at an average premium of almost $4 per barrel
compared with the contract for delivery six months later.
The backwardation was in the 91st percentile, implying traders expected
inventories to deplete further in the near term, but with supplies expected to
remain comfortable in the longer term.
Saudi Arabia and its OPEC⁺ allies are expected to maintain production cuts
through June 2024 to deplete inventories further and support prices before
gradually increasing output in the second half and into 2025.


U.S. OIL INVENTORIES

In contrast to the rest of the world, where data on inventories is only
available with a delay of several months, if at all, in the United States the
EIA publishes stock data with a lag of less than a week.
With some justification, traders tend to use high-frequency data on U.S.
inventories as a proxy for the production-consumption balance in the broader
global market.
U.S. commercial crude inventories were almost exactly in line with the prior
10-year seasonal average on April 12, and there has been very little net change
over the last three months.
Inventories around the delivery point for the NYMEX futures contract at Cushing
in Oklahoma were 13 million barrels (-29% or -0.88 standard deviations) below
the ten-year seasonal average.
The deficit explains the strong backwardation in both U.S. crude and Brent
futures prices, but it has been narrowing over the last three months.
U.S. commercial crude inventories are consistent with a market only a little
tighter than the long term average, not the sort of conditions that precede a
large and sustained spike in prices.


NO CATASTROPHISING

The cycle of retaliation between Iran and Israel has potential for uncontrolled
escalation, as each government tries to restore deterrence and demonstrate
resolve to domestic and international audiences.
The conflict could escalate to the point it disrupts production and tanker
traffic from Iran and other countries around the Gulf. Traders are not ignoring
the risk, but treating it as a less-likely tail risk, rather than a central
scenario.
Refusing to catastrophise about loss of Iranian oil production and closure of
the Strait of Hormuz is rational given how many times these extreme scenarios
have been predicted but failed to materialise over the last 30 years.
The risk of a sudden loss of production and exports is not zero, but nor is it
high enough to require prices to rise sharply to restrain consumption, build
even larger inventories and create more spare capacity to mitigate it.
Unless and until the threat to Gulf production and exports becomes more
concrete, rather than just perennial speculation, current prices and spreads
look consistent with a market that is only moderately tighter than usual.
Related column:
- Oil traders expect stocks to fall significantly after OPEC extends cuts (March
21, 2024)
- Record U.S. oil and gas production keeps prices under pressure (March 1, 2024)
- Western Hemisphere oil output surges, with a helping hand from OPEC (February
21, 2024)
- Why the oil market refuses to catastrophise (January 18, 2024)
John Kemp is a Reuters market analyst. The views expressed are his own. Follow
his commentary on X https://twitter.com/JKempEnergy, opens new tab

Get a look at the day ahead in U.S. and global markets with the Morning Bid U.S.
newsletter. Sign up here.

Editing by David Evans

Our Standards: The Thomson Reuters Trust Principles., opens new tab

 * Suggested Topics:
 * Commodities
 * Exploration & Production
 * OPEC
 * Storage
 * Transport Fuels

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Purchase Licensing Rights
John Kemp

Thomson Reuters

John Kemp is a senior market analyst specializing in oil and energy systems.
Before joining Reuters in 2008, he was a trading analyst at Sempra Commodities,
now part of JPMorgan, and an economic analyst at Oxford Analytica. His interests
include all aspects of energy technology, history, diplomacy, derivative
markets, risk management, policy and transitions.

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