Clock Ticking On Iran

Jim Brown
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Iran said they had shutdown some fields for maintenance and would be cutting exports by up to 30% until the maintenance was completed. You have to love a country that never lets the facts get in the way of a press release.

Iran said exports would decline by up to 30% because they were shifting some additional oil to cover internal refinery requirements because gasoline and diesel demand was growing. They also said long delayed oilfield maintenance would reduce output of oil for sale.

Iran can't officially admit that the sanctions and embargo are slowing exports because that would mean they were suffering at the hands of the great satan (USA) and Europe. Since most average people in the Middle East get their news from the official government channels they don't realize the extent of the sanctions. For them whatever the government tells them is assumed to be basically accurate. Positive press releases are a way to keep the charade going.

Iran said its current exports of 2.2 mbpd could decline to 1.54 to 1.76 mbpd as a result of the "maintenance." Analysts believe the real number will fall to around 1.3 mbpd. In reality the sanctions are crippling Iran's oil sales. Starting on July 1st there is a ban against insuring Iranian oil cargoes that will hurt them significantly because buyers of the oil will not be able to ship it without insurance.

Iranian owned oil tanker company NTIC renamed at least ten of its vessels and switched them to a Tanzanian flag because of growing curbs on shipping Iranian oil. Five VLCC tankers capable of carrying 2 million barrels each and five Suezmax tankers at 1.0 million barrels had their ownership changed from NTIC to new companies. However, those new companies kept the NTIC mailing address in Tehran. The attempt to conceal the ownership was exceedingly clumsy.

Iran has also forced the tanker operators to turn off their electronic ID systems that allow analysts to track tanker fleets worldwide using GPS satellites. Iran wants the tankers to disappear once out of the Persian Gulf. There have also been headlines about tankers appearing in overseas ports with different names freshly painted over the name they had when they left the Iranian port.

The IEA said this week that Iran is currently using 25 of its 39 NTIC tankers to store crude oil that is unsold.

South Korea said it would stop buying Iranian crude on July 1st because of the lack of insurance for the cargos. In May they imported 40% less crude from Iran because of U.S. sanctions. They imported 87 million barrels of oil from Iran in 2011. Purchases had already been reduced from 7.0 million barrels in January to 3.9 million in May. After the Korean announcement Iran said it may halt imports of goods made in South Korea if the country backs out of its crude purchase contracts.

Oil prices rose on Wednesday as the embargo draws near but there were also some other headlines providing support. A worker strike in the North Sea has cut output by 240,000 bpd. There are no expectations for a quick end to the strike and the Norwegian government said it was not going to intervene.

Tropical Storm Debby has evaporated but not before shutting down a significant number of platforms in the Gulf of Mexico. Debby's initial track was headed west directly towards the oil patch but it reversed to an easterly direction early in the week and evaporated after she made landfall in Florida. While the threat existed as much as 44% of gulf oil output was shut in as a precaution. That is several days of output that will be reflected in inventory drops over the next couple of weeks.

Crude oil inventories in the U.S. declined by -100,000 barrels according to the EIA report on Wednesday. That was significantly less than the -1.3 million barrel drop analysts had expected. The inventory decline was helped by a drop in imports of -312,000 bpd or more than 2.1 million barrels for the week. Domestic production also declined by -96,000 bpd. Record Cushing inventories fell slightly by -400,000 barrels to 47.4 million. U.S. crude inventories are 7.7% above the same period in 2011.

Distillate inventories declined by -2.3 million barrels. The decline was caused by a surge in demand of more than +322,000 bpd. Inventories of distillates are -16.5% lower than the same period in 2011.

Gasoline inventories rose by +2.1 million barrels. Imports declined by -225,000 bpd but production increased by +258,000 bpd. Year over year gasoline demand has declined for 66 consecutive weeks thanks to more economical cars and the more than 20 million people out of work.

Refinery utilization rose to 92.6% and the highest level in 2012. The cheap oil and relatively high fuel prices are making it profitable to increase the refining runs and stockpile refined products. Retail prices never fall as fast as crude so there is a period after a price spike where margins are expanded. This makes up for the period during the spike where margins are compressed. Refiners able to access WTI crude are making a killing buying cheap WTI oil and selling gasoline and diesel at Brent prices. Exports of refined products are 45% greater than year ago levels.

EIA This Week in Petroleum

Inventory Snapshot

Oil Inventory Chart

Gasoline Inventory Chart

Distillate Inventory Chart

Brent prices have rallied nearly $5 from the low of $89 on Thursday. This is due to the impending Iranian embargo, the strike in Norway and expectations for a slowdown in OPEC production. A temporary halt of supplies from the Gulf of Mexico probably helped.

After a very bad six weeks for oil prices it would not be surprising to see fund managers bargain hunting in the sector ahead of quarter end. According to a Bloomberg study energy stocks are now -43% below the S&P's relative performance since the bottom in 2009. Considering how much oil prices have risen from the $30 low in 2009 you would think energy stocks would be setting new highs. Unfortunately expectations for the energy sector are tied to global economic expectations and those are not doing well at present.

Bloomberg found that every time energy stocks lagged the S&P for four months or more the S&P eventually declined around 12% over the next three months. The S&P Energy Index traded at 5.34 times the price of oil in the second quarter compared to an average of 7x over the past two decades. Energy equities are now averaging a PE of 9.5 compared to the S&P at 13.3 and the widest discount since September 2009.

Clearly energy equities are cheap but until the global economy firms they can get cheaper. Oil, both Brent and WTI have exceeded my worst case projections for declines. The drop has scared investors and TV commentators are now calling for $60 oil. At least those trying to get a headline are calling for $60. The more reputable analysts agree we could see a test of $75 but they believe long term prices will rise as the year progresses and demand slowly increases. Global consumption is expected to rise to a record of 89.9 mbpd by year end. There are quite a few analysts that never believed we would ever produce 90.0 mbpd. Given Saudi Arabia's struggle to maintain 10.0 mbpd over the last several months we could easily be topping out here but we won't know that for years to come.

The production numbers are confused by having NGLs, bio fuels, gas to liquids, etc all thrown into the liquids mix even though NGLs are not a transportation fuel. All demand is aggregated and so is all liquids production so "oil" production may never reach 90.0 mbpd even though uneducated reporters claim it to be so.

The current low oil prices are going to provide a strong boost to the global economy. The economy runs on oil and cheap oil increases economic activity. We know from experience that oil prices cycle and high prices kill growth while low prices fuel growth. The current levels should be Miracle Gro for the U.S., Europe and Asia so now is the time to be patient and wait for the green shoots to appear.

The wildcards this week are the EU summit and Iran. If the EU leaders finally come up with a plan to solve the problems once and for all then growth will appear. Otherwise we are in for a slow decline until they do pull out the bazookas. Even if Iran does not cause trouble in the Strait of Hormuz I would expect them to be fairly vocal about the embargo and the potential for high oil prices to harm Europe's economy. They will try and talk up prices so they can get the most revenue out of the remaining oil they can sell.

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Jim Brown

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