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Crude Breakout Likely as Geopolitical Risk Factors Pile Up

05/21/2019 1:26 pm EST

Focus: COMMODITIES

Phil Flynn

Senior Energy Analyst, The PRICE Futures Group

While supply figures tighten, geopolitical risk factors in the energy space continue to pile up warns Phil Flynn.

Oil prices that have consolidated higher in May, could just run away in June. Oil, shaking off fears of a trade war and slowing demand talk, will have to face the fact of a tightening global oil supply. OPEC has already said that they intend to keep production quotas in place until the end of the year, even though Venezuelan oil production continues to fall and reports that global oil demand cover is at its lowest level in years.

The Energy Information Administration reported that in April 2019, Venezuela's crude oil production averaged 830,000 barrels-per-day (bpd), down from 1.2 million bpd at the beginning of the year. This average is the lowest level since January 2003, when a nationwide strike and civil unrest largely brought the operations of Venezuela's state oil company, Petróleos de Venezuela, S.A. (PdVSA), to a halt. Widespread power outages, mismanagement of the country's oil industry, and U.S. sanctions directed at Venezuela's energy sector and PdVSA have all contributed to the recent declines.

The IEA said that “Venezuela’s oil production has decreased significantly over the last three years. Production declines accelerated in 2018, decreasing by an average of 33,000 bpd each month in 2018, and the rate of decline increased to an average of over 135,000 bpd per month in the first quarter of 2019. The number of active oil rigs—an indicator of future oil production—also fell from nearly 70 rigs in the first quarter of 2016 to 24 rigs in the first quarter of 2019. The declines in Venezuelan crude oil production will have limited effects on the United States, as U.S. imports of Venezuelan crude oil have decreased over the last several years. EIA estimates that U.S. crude oil imports from Venezuela in 2018 averaged 505,000 bpd and were the lowest since 1989.

U.S. gasoline and distillate supply are below average and floating storage is at a three-year low. With U.S. consumer confidence strong, demand more than likely will surprise on the upside.  Global spare oil production capacity is tightening and should fall below 2 million barrels to about 1.5 million bpd in the third quarter as demand growth sops up extra barrels. Gas crack spreads are strong as refiners will need incentive to meet what should be record demand.

Now, add that to the geopolitical risk factors from U.S. tensions with Iran. Reuters reported that President Donald Trump warned Iran would be met with “great force” if it attacked U.S. interests in the Middle East, and government sources said Washington strongly suspects Shi’ite militias with ties to Tehran were behind a rocket attack in Baghdad’s Green Zone.

This comes after the IEA warned that global stockpiles are set to plunge sharply this quarter as demand picks up and as U.S. sanctions squeeze production in Iran, which could fall this month to the lowest since the country’s war with Iraq in the 1980s. Now today, the API had better show a crude oil increase or the bulls will be ready to take this market over.

Reuters said that an Iranian news service reported on a fourfold increase in Iran’s rate of production of low-grade uranium enrichment. Quoting an official at the Natanz enrichment plant, the semi-official Tasnim news service said Iran was accelerating the rate of production at which it refines uranium to 3.67% fissile purity, suitable for civilian nuclear power generation.” Or bombs depending on how you want to use it.

The Financial Times reports that the United States is considering sanctions on Russia’s controversial Nord Stream 2 gas pipeline to Germany. The Nord Stream 2, which runs from Russia to Germany under the Baltic Sea, has been condemned by the United States and some EU countries as a political tool for the Kremlin to increase its control over Europe’s energy supply, and a means to hurt Kiev by reducing the amount of gas transited through Ukraine. The FT wrote that ‘“The opposition to Nord Stream 2 is still very much alive and well in the United States,” Mr. Perry told reporters at a briefing in Kiev during a trip to attend the inauguration of new president Volodymyr Zelensky. “The United States Senate is going to pass a bill, the House is going to approve it, and it’s going to go to the President and he’s going to sign it, that is going to put sanctions on Nord Stream 2,” Mr. Perry said, in comments published by Reuters. The pipeline is currently under construction and will run alongside the already operational Nord Stream. The Kremlin said it was confident that the project would be completed regardless of U.S. actions.”

Still, it shows how the Trump administration is wary of the threat by Russia to once again use natural gas as a political weapon. Russia wants to control not only the production of natural gas and its transportation to exert its political power over the region.  Russia’s quest to control energy was its main reason for invading Ukraine’s Crimean Peninsula and backed pro-Russian separatist forces in eastern Ukraine. Russia’s Gazprom cut supply of gas in 2005, 2009 and in 2014.

Risk factors are piling up and we expect oil is on the verge of another upside breakout.

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