The oil market may be underestimating Iran’s ability to disrupt oil flows in and out of the Middle East and its potential repercussions.
Consensus opinion has been dismissive of Iran’s recently renewed threats to block oil flows through the Strait of Hormuz in retaliation against US sanctions as pure bluster, especially in view of the heavy US military presence around the Persian Gulf. But an attack by the Iran-aligned Houthi rebels in Yemen on two Saudi oil tankers, which prompted Aramco to indefinitely suspend oil shipments through the Bab el-Mandeb strait from July 26, shows that Tehran has the other major chokepoint of the Arabian Peninsula within its reach as well.
Other Middle Eastern producers’ oil shipments through the Bab el-Mandeb, a narrow waterway that connects the Red Sea with the Arabian Sea, have remained normal and traders were expecting Saudi shipments to resume once the kingdom had made adequate security escort arrangements for its tankers. But it would be dangerous to discount the nuisance value of the Houthis, who have stepped up missile attacks against Saudi Arabia over the past several months, and who may be leveraged even more by Tehran amid an escalating war rhetoric with the US.
While the target of the Houthi rebels, who took over the government in Sana’a in late 2014, is Saudi Arabia, which backs the now exiled government of Yemen, an escalation of attacks in the Bab el-Mandeb strait or the Red Sea could bring all oil traﬃc through those waters to a complete halt.
The strait is a busy channel for crude and refined product shipments moving in both directions, north and south. An estimated 4.8 million b/d of crude and refined products flowed through the waterway in 2016, according to the US Energy Information Administration. The strait is also a conduit for Middle East crude and refined product shipments to Europe and the US through the Suez Canal and the SUMED pipeline to its north in Egypt, which connect the Red Sea to the Mediterranean Sea. Some 3.9 million b/d of crude and products passed through the Suez Canal in 2016, while the SUMED pipeline system has the capacity to move 2.34 million b/d of crude, according to the EIA.
Crude flows into and refined product exports out of the Yanbu and Rabigh refineries on the west coast of Saudi Arabia, each with a capacity of 400,000 b/d, also need access to the Bab el-Mandeb. Only the Yanbu refinery can receive Saudi crude from Jubail via an overland East-West pipeline system.
For Iran, targeting the Bab el-Mandeb and onshore Saudi oil installations through the Houthis provides wider access to the kingdom’s facilities as well as deniability, which it would not have, were it to attack the Strait of Hormuz on its own.
The crude market largely shrugged oﬀ the growing war of words between the US administration and Iranian leaders this week. But it will be forced to take notice if the Houthis escalate attacks against Saudi Arabia and maybe even its ally the UAE, or continue targeting ship movements through the Red Sea. Houthis claimed they attacked the international airport in Abu Dhabi using an armed drone that flew over 1,500 km to its destination on Thursday, though the UAE flatly denied such an incident occurred, while experts doubted that the rebels have such capability.
Though crude’s price recovery this week from the depths plumbed last week was also helped by a draw reported for last week in US crude and refined product stocks, the upside was limited. Two major bearish factors remain in view: increased supply from Saudi Arabia and a few other OPEC/non-OPEC producers, and a possible slowdown in oil demand if the US-China trade war continues to fester.
A potential supply shock if Washington adopts a tough stance against buyers of Iran crude may seem distant, given the November 4 implementation of US sanctions against Iran’s oil sector. But the Bab el-Mandeb attack this week shows oil supply could be jolted from other directions and at any time.
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Headline crude prices for the week beginning 20 May 2019 – Brent: US$73/b; WTI: US$63/b
Headlines of the week
Midstream & Downstream
At first, it seemed like a done deal. Chevron made a US$33 billion offer to take over US-based upstream independent Anadarko Petroleum. It was a 39% premium to Anadarko’s last traded price at the time and would have been the largest industry deal since Shell’s US$61 billion takeover of the BG Group in 2015. The deal would have given Chevron significant and synergistic acreage in the Permian Basin along with new potential in US midstream, as well as Anadarko’s high potential projects in Africa. Then Occidental Petroleum swooped in at the eleventh hour, making the delicious new bid and pulling the carpet out from under Chevron.
We can thank Warren Buffet for this. Occidental Petroleum, or Oxy, had previously made several quiet approaches to purchase Anadarko. These were rebuffed in favour of Chevron’s. Then Oxy’s CEO Vicki Hollub took the company jet to meet with Buffet. Playing to his reported desire to buy into shale, Hollub returned with a US$10 billion cash infusion from Buffet’s Berkshire Hathaway – which was contingent on Oxy’s successful purchase of Anadarko. Hollub also secured a US$8.8 billion commitment from France’s Total to sell off Anadarko’s African assets. With these aces, she then re-approached Anadarko with a new deal – for US$38 billion.
This could have sparked off a price war. After all, the Chevron-Anadarko deal made a lot of sense – securing premium spots in the prolific Permian, creating a 120 sq.km corridor in the sweet spot of the shale basin, the Delaware. But the risk-adverse appetite of Chevron’s CEO Michael Wirth returned, and Chevron declined to increase its offer. By bowing out of the bid, Wirth said ‘Cost and capital discipline always matters…. winning in any environment doesn’t mean winning at any cost… for the sake for doing a deal.” Chevron walks away with a termination fee of US$1 billion and the scuppered dreams of matching ExxonMobil in size.
And so Oxy was victorious, capping off a two-year pursuit by Hollub for Anadarko – which only went public after the Chevron bid. This new ‘global energy leader’ has a combined 1.3 mmb/d boe production, but instead of leveraging Anadarko’s more international spread of operations, Oxy is looking for a future that is significantly more domestic.
The Oxy-Anadarko marriage will make Occidental the undisputed top producer in the Permian Basin, the hottest of all current oil and gas hotspots. Oxy was once a more international player, under former CEO Armand Hammer, who took Occidental to Libya, Peru, Venezuela, Bolivia, the Congo and other developing markets. A downturn in the 1990s led to a refocusing of operations on the US, with Oxy being one of the first companies to research extracting shale oil. And so, as the deal was done, Anadarko’s promising projects in Africa – Area 1 and the Mozambique LNG project, as well as interest in Ghana, Algeria and South Africa – go to Total, which has plenty of synergies to exploit. The retreat back to the US makes sense; Anadarko’s 600,000 acres in the Permian are reportedly the most ‘potentially profitable’ and it also has a major presence in Gulf of Mexico deepwater. Occidental has already identified 10,000 drilling locations in Anadarko areas that are near existing Oxy operations.
While Chevron licks its wounds, it can comfort itself with the fact that it is still the largest current supermajor presence in the Permian, with output there surging 70% in 2018 y-o-y. There could be other targets for acquisitions – Pioneer Natural Resources, Concho Resources or Diamondback Energy – but Chevron’s hunger for takeover seems to have diminished. And with it, the promises of an M&A bonanza in the Permian over 2019.
The Occidental-Anadarko deal:
Source: U.S. Energy Information Administration, Short-Term Energy Outlook
In April 2019, Venezuela's crude oil production averaged 830,000 barrels per day (b/d), down from 1.2 million b/d at the beginning of the year, according to EIA’s May 2019 Short-Term Energy Outlook. 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.
Source: U.S. Energy Information Administration, based on Baker Hughes
Venezuela’s oil production has decreased significantly over the last three years. Production declines accelerated in 2018, decreasing by an average of 33,000 b/d each month in 2018, and the rate of decline increased to an average of over 135,000 b/d 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 b/d and were the lowest since 1989.
EIA expects Venezuela's crude oil production to continue decreasing in 2019, and declines may accelerate as sanctions-related deadlines pass. These deadlines include provisions that third-party entities using the U.S. financial system stop transactions with PdVSA by April 28 and that U.S. companies, including oil service companies, involved in the oil sector must cease operations in Venezuela by July 27. Venezuela's chronic shortage of workers across the industry and the departure of U.S. oilfield service companies, among other factors, will contribute to a further decrease in production.
Additionally, U.S. sanctions, as outlined in the January 25, 2019 Executive Order 13857, immediately banned U.S. exports of petroleum products—including unfinished oils that are blended with Venezuela's heavy crude oil for processing—to Venezuela. The Executive Order also required payments for PdVSA-owned petroleum and petroleum products to be placed into an escrow account inaccessible by the company. Preliminary weekly estimates indicate a significant decline in U.S. crude oil imports from Venezuela in February and March, as without direct access to cash payments, PdVSA had little reason to export crude oil to the United States.
India, China, and some European countries continued to receive Venezuela's crude oil, according to data published by ClipperData Inc. Venezuela is likely keeping some crude oil cargoes intended for exports in floating storageuntil it finds buyers for the cargoes.
Source: U.S. Energy Information Administration, Short-Term Energy Outlook, and Clipper Data Inc.
A series of ongoing nationwide power outages in Venezuela that began on March 7 cut electricity to the country's oil-producing areas, likely damaging the reservoirs and associated infrastructure. In the Orinoco Oil Belt area, Venezuela produces extra-heavy crude oil that requires dilution with condensate or other light oils before the oil is sent by pipeline to domestic refineries or export terminals. Venezuela’s upgraders, complex processing units that upgrade the extra-heavy crude oil to help facilitate transport, were shut down in March during the power outages.
If Venezuelan crude or upgraded oil cannot flow as a result of a lack of power to the pumping infrastructure, heavier molecules sink and form a tar-like layer in the pipelines that can hinder the flow from resuming even after the power outages are resolved. However, according to tanker tracking data, Venezuela's main export terminal at Puerto José was apparently able to load crude oil onto vessels between power outages, possibly indicating that the loaded crude oil was taken from onshore storage. For this reason, EIA estimates that Venezuela's production fell at a faster rate than its exports.
EIA forecasts that Venezuela's crude oil production will continue to fall through at least the end of 2020, reflecting further declines in crude oil production capacity. Although EIA does not publish forecasts for individual OPEC countries, it does publish total OPEC crude oil and other liquids production. Further disruptions to Venezuela's production beyond what EIA currently assumes would change this forecast.