Commodities

What’s next for oil prices? – Commodity News

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Following the US decision to unilaterally withdraw from the Iran nuclear deal, a cloud of uncertainty is hanging over oil markets, with traders scrambling to figure out to what extent this will impact oil prices. In this respect, price action in oil may depend mainly on whether Iran and the US begin new negotiations, whether other major producers raise their own supply to “fill the gap” left by Iran, and on how the geopolitical situation plays out in the Middle East.

The US President announced earlier this week that his nation will withdraw from the Iranian nuclear deal of 2015, and that it will reimpose the “highest level” of sanctions on Iran. Crucially though, he also kept the door open for negotiating a new deal, which seems to be the ultimate goal here. The unilateral departure by the US appears like a “hardball” negotiating tactic aimed at bringing Iran to the table for new talks, in similar fashion to how the US imposed tariffs on China, only to postpone them and quickly seek negotiations.

Some sanctions will be imposed after a 90-day period, and the full set of sanctions will be reinstated in 180 days, on November 4. Theoretically, a new deal could be reached before that time. Oil prices surged significantly in anticipation of these sanctions, reaching multi-year highs on expectations for reduced supply. Iran currently produces 3.82 million barrels per day (mbd), making it OPEC’s third-biggest producer. It’s also the world’s fifth largest exporter, shipping roughly 2.5 million mbd according to IEA data.

Importantly, all other nations in the accord (UK, France, Germany, China, Russia, Iran) indicated their willingness to remain in, which at first glance makes the unilateral withdrawal by the US seem much less impactful – especially since the US doesn’t import oil from Iran. Taking a closer look though, that may not be a game-changer for the oil market. Once the US imposes full sanctions, it can take action against European and Asian firms doing business with Iran, pressuring them to reduce their purchases. That would effectively reduce Iranian exports even if the EU and other nations stay in the pact, though the amount of crude that is taken off the market will probably be much less than the 1 mbd reduction in 2012, as there is no international coalition behind the US this time around.

Does that mean oil prices are heading higher from here? Not necessarily – it will all depend on how the US-Iran negotiations play out, and perhaps even more importantly, how the other major oil producers react to the loss in supply. For instance, if major producers rush to “fill the gap” by increasing their own production, then prices are unlikely to rise much further. The most prominent players to do so would be the nations in the OPEC and non-OPEC supply pact, led by Saudi Arabia and Russia respectively, both of which have ample spare production capacity that can be put to work if needed.

Another question is how US producers will respond. Under normal circumstances, one would expect US firms to increase production to replace any lost crude. Alas, this may not be the case this time, as several US oil companies are apparently experiencing capacity constraints – namely insufficient pipeline capacity to be able to transport crude – which may not allow them to raise production as much, or as quickly, as they would have otherwise wanted. Reflecting this, US Treasury Secretary Mnuchin has reached out to large foreign producers about ways to increase their supply, which makes the scenario of Saudi Arabia and OPEC potentially filling that gap appear more likely.

On the other hand, an issue that requires observation and represents an upside risk for oil prices, is the rising possibility of military conflict in the Middle East, following a clear intensification in geopolitical tensions recently. On Thursday, Israel said it carried out strikes against Iranian targets in Syria, after Iranian forces launched a rocket attack on Israeli military bases. The situation is quite fragile and worth monitoring closely, as any further escalation could carry large implications for the region’s stability and hence, lead to speculation for even further disruptions to global supply.

Besides all the above, any major movements in the dollar, as well as any supply outages elsewhere in the world – and most notably Venezuela – also have the capacity to move oil prices.

Taking a technical look, WTI reached a three-and-a-half year high of $71.89/barrel on Thursday, and it will be crucial to see whether it can break above it and post a higher high. An upside break of that area could open the way for the low of November 2014, at $73.30. Further up, focus would shift to the psychological figure of $75.00.

In case of declines in WTI – for example if other major suppliers announce they will ramp up their production – then prices may encounter support initially near the $69.40 zone, which halted several advances in late-April. If the bears manage to overcome that area, buy orders may be found near $66.85, the low of May 1. Even lower, the $65.55 figure could come into play, defined by the trough of April 17.