The market peaked on Tuesday morning, barely 48 hours ago, yet it feels like lightyears away. Oil prices have been falling as fast as it takes to dismantle the European Super League. The only difference is that the former will likely rise from the ashes. The optimism of the recent past based on healthy 2H 2021 demand growth, a weak dollar and the force majeure in Libya gave way to re-surfacing concerns about the fight against the health pandemic. India registers record daily infection rates and death toll. Major Japanese cities are considering a state emergency amidst soaring Covid cases. Add to that the unexpectedly positive ambience surrounding the US-Iranian nuclear talk and all of the sudden healthy stock depletion in the latter part of the year is not guaranteed.

The weekly EIA statistics did not help either yesterday. The bottom line is that commercial oil inventories in the US grew by 3.5 million bbls. Crude oil inventories registered a slight increase thanks to the 1.2 million bbls build in the USGC. Cushing stocks fell 1.3 million bbls. As refinery runs remained unchanged at 85% on the week gasoline stocks hardly moved. Distillate inventories, on the other hand registered a draw of 1.1 million bbls. This is the exact opposite of what weekly demand data would suggest. Gasoline consumption has broken above the 9 mbpd mark as more motorists take to the roads whilst distillate demand has fallen by nearly 300,000 bpd to 3.9 mbpd. Total US product consumption was down 2.6 mbpd week-on-week, mainly because of the 800,000 bpd decline in the “other oil products” category.

The untamed virus in certain parts of the world coupled with negative US inventory report and the progress in the Iranian nuclear talks has made oil bulls careful and conservative. Both WTI and Brent fell more than $1/bbl yesterday. The prices weakness of the last two days is more of liquidating long positions than betting on protracted cheapening of oil prices. The Brent structure is solid and the CFD market is also showing signs of revival. The Week 2/Week 8 Brent CFD differential that displayed a backwardation of 20 cents/bbl two weeks ago is now + 80 cents/bbl. And for those who doubt that the pandemic will ever be beaten an FT analysis provides a helping hand. There is a clear evidence all over the world that the rise in infection rates, hospitalization and death all show downward trajectory in age groups that have already been vaccinated. Vaccination is working and the virus will be overcome. The light at the end of the pandemic tunnel is firmly visible, only the length of the remainder of the journey is unclear.

Can increased Iranian production be managed?

Despite the upbeat mood in the nuclear talks no immediate break-through is anticipated. Yet, it was the noise coming out of the meeting in Vienna that triggered a nearly $2/bbl sell-off in 30 minutes on Tuesday afternoon. Iran said on Tuesday that its enrichment of uranium up to 60% was a demonstration of its technical capabilities after its Natanz plant was sabotaged last week, nevertheless the move can quickly be reversed “if other parties commit to the obligations”. The Iranian delegation labelled the ongoing negotiations as one that is heading the right direction, but the representative of the European Union was quick to emphasize that much more hard work is required.

The aim of the talks is to return to the 2015 agreement between Iran and the six world powers that limited Iranian enrichment at less than 4% in return for lifting economic sanction that had paralyzed the country’s economy. These included the resumption of Iranian oil exports. Despite a deal and therefore the Iranian comeback to the “official” global oil export market is not something that is impending it is worth having a look at how the global oil balance would change in case Iran returns and how these extra barrels could be allocated within the OPEC+ alliances

The latest OPEC report puts 2H 2021 global oil demand at 98.60 mbpd, 3.51 mbpd above the 2Q estimate. In case the pandemic takes longer to bring under control than currently anticipated some downward revisions might be in order next month. The demand for OPEC oil is set to rise from 26.84 mbpd in 2Q to 28.62 mbpd in 2H, a growth of 1.78 mbpd. Demand growth will outpace the increase in OPEC call.

On the supply front OPEC members with output constraints will be allowed to pump 23.03 mbpd at the beginning of 2H. If extra Iranian production will need to be allocated it is a reasonable to assume that this level would be maintained through the year. Add to that an output of around 1.2 mbpd from Libya (assuming that the current force majeure will be lifted) and 600,000 bpd from Venezuela and you end up with slightly less than 25 mbpd.

Current Iranian output is about 2.3 mbpd. This compares with 3.8 mbpd before Donald Trump abandoned the nuclear agreement in 2018. Should the unexpected happen and Iran will re-emerge as a crude oil exporter in the next few months its output would top out around 3 mbpd this year making the total expected production from OPEC around 28 mbpd. This is then set against the estimated OPEC call of 28.62 mbpd.

The above exercise foresees a global stock depletion of a mere 620,000 bpd versus our current estimate of 1.82 mbpd. The difference is significant and the “Iran return” scenario would seriously slow down pace of global stock draws. Consequently, the nuclear talks will be closely followed, and they will likely cause regular adverse price movements until a final agreement is reached one way or the other. As for the producer group’s ultimate objective -ie. reaching the 2015-2019 average in OECD oil stocks- the later Iranian sanctions are lifted, the better it is as global oil demand is expected to expand further in 2022 as the war on the virus is being slowly won.