Vinod Sharma
Crude prices have surged above the USD 52 mark as President Trump refused to certify that Iran is following the spirit of the 2015 Nuclear agreement. This puts the 2015 accord in jeopardy.
Crude prices were also boosted as Iraqi troops seized parts of the oil-rich Kurdish region.
The fear is that Trump's refusal to certify may be the first step in the abrogation of the treaty.
Iran and the group of P5+1 ( The 5 permanent members of the UN Security Council – USA, UK, France, Russia, China, and Germany) had signed the deal in Vienna on July 14, 2015.
Under the deal, Iran offered to cap its nuclear programme in exchange for allowing it to export crude oil.
If the US was to abrogate the treaty then sanctions would be back on oil exports to Iran, which could lit a fire under the crude pot as a million barrels suddenly vanish into thin air.
We for one believe that even if the sanctions were to return on Iranian exports this would be the last hurrah for oil.
Secondly, the Kurd Oil fields continue to pump, albeit under Iraqi supervision now. There has been no destruction of fields.
We do not foresee the WTI Crude ever crossing the USD 60 a barrel in the near future, and definitely not on a sustained basis.
How much would crude oil supply vanish?
Last month, Iran produced 3.827 million barrels a day and exported 2.28 million barrels per day (bpd). It consumed around 1.5 million barrels per day.
Before the deal, Iran was producing close to 2.78 million barrels a day and exporting around 1.7 million barrels a day. Exports prior to the deal were allowed on humanitarian grounds.
The deal has essentially put 0.58 million barrels a day more in the market. So this is at the most that will go off exports.
Discordant notes in the P5+1
Trump’s refusal to certify that the Iran is following the spirit of the 2015 agreement is quite in contrast to the view of the P4+1. Germany, Britain, France, Russia and China and the UN nuclear watchdog all say that Iran has abided by the terms of the agreement.
There could be a division in the P5+1 and it would mean status quo of Iranian exports.
We think that the US will not abrogate but even if it does, we do not see WTI Crude going beyond the USD 60 a barrel mark.
Why USD 60 A barrel is just a dream
We believe that USD 60 a barrel in WTI is just a dream because of two reasons.
US Shale – The Original Enemy
US shale has been the bane of OPEC. In 2014, Saudi Arabia gambled by cutting down prices of oil but increasing production in order to shut down shale oil as not all producers make profit below USD 50 a barrel.
But Saudis had to blink in 2016 when they brought back the quotas in OPEC to maintain prices.
Any surge in crude beyond USD 60 can’t last as shale oil producers will flood the markets. The US has now become a swing producer with the ability to produce more if it is profitable.
Electric vehicles – emerging alternative that will reduce demand
As the world’s largest auto market, China’s electric-vehicle (EV) policy, which is still being formulated, could supercharge the race for EVs. China is expected to come down heavily on autos that cloud its skies with pollution.
According to the Financial Times, China plans to produce 7 million EVs per year by 2025 and to spend at least USD 60 billion on related subsidies between 2015 and 2020.
India has already taken a lead by having an auto policy that sees all new vehicles on road in 2030 to be electric.
With two of the most populous nations working towards EV push, crude oil is likely to see less demand. A Bloomberg New Energy Finance report predicts EVs will cut crude demand by 8 million barrels a day by 2040. This could send chills down the spines of oil sheikhs.
Then, there are others who think growing interest in alternative energy fuels could drive oil prices to USD 10 a barrel over the next six to eight years.
OPEC’s Own Enemy’s within
While OPEC puts quotas in place to control production, they are never honoured in full. The OPEC countries have been used to the ill-gotten wealth and accordingly increased their expenses.
Now at half the rates that prevailed 3 years ago, they have to curtail their public expenditure, which could result into an uprising any time. If crude prices rise, OPEC producers will produce more than the quota.
And if this time the crude falls below USD 40, it will probably never recover because they know that electric vehicles will kill the demand, which means that they will then produce as fast as they can. The OPEC quotes will cease to exist.
Straws in the wind:
Saudi Aramco’s IPO seems to have been shelved, but its very thought originated from the Saudi Belief that Crude Oil is on a downhill. Saudis probably wanted to sell Aramco before crude collapsed.
Reliance Industries has also sold off its overseas oil assets. They will probably now work on the battery energy and its solutions.
Conclusion
We believe this is the last hurrah for crude oil prices and investors will do well to lighten their commitments in the upstream oil companies.
There are lessons for the government as well. They should privatise the upstream oil business as fast as they can and also break up Coal India and divest as the energy sector will change without adequate notice.
Otherwise, ONGC, Oil India, and Coal India will go the way of BSNL.
(Disclosure : Reliance Industries Ltd. is the sole beneficiary of Independent Media Trust which controls Network18 Media & Investments Ltd.)
(Disclaimer: The author is Head PCG & Capital Market Strategy at HDFC Securities Ltd. The views and investment tips expressed by investment expert on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.)
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