U.S. Oil Tops $70 a Barrel as Deadline Nears on Iran
Posted May 7, 2018 8:35 p.m. EDT
A cutback in world oil output, engineered by some of the biggest producers, has more than doubled prices from their ebb two years ago. Now, a looming decision by President Donald Trump on the Iran nuclear agreement is pushing them even higher.
Benchmark prices for U.S. crude oil closed above $70 a barrel on Monday for the first time since 2014 as traders factored in a prospective U.S. withdrawal from the accord, which eased international sanctions on Iran in exchange for restrictions on its nuclear program.
Investors fear that a withdrawal would lead to new sanctions on Iran, the world’s fifth-largest producer of crude oil in 2017, further curtailing a global supply that is already relatively tight.
Trump has threatened to pull out unless Britain, France and Germany agree to make wholesale changes to the agreement. Late Monday, the president said he would announce his decision Tuesday afternoon.
“The market is watching nervously,” Ann-Louise Hittle, an oil analyst at the market research firm Wood Mackenzie, said of the deadline.
Analysts estimate that reimposing sanctions on Iran could reduce the country’s daily oil sales by 300,000 to 600,000 barrels, or perhaps as much as 1 million barrels. But imposing new sanctions would most likely take time. And if prices stay high, Iran could increase its earnings from oil sales in the short run.
“Our base case is the rollout of sanctions will be quite slow and messy,” said Ben Cahill, an analyst at the market research firm Energy Intelligence.
“In the very short term,” he added, “the price runup could benefit” Iran.
That threat of a reduction in supply coincides with production cuts by the Organization of the Petroleum Exporting Countries and Russia, one of the world’s largest oil producers, that have helped drain a glut that was depressing prices. Their deal was reached in 2016 and began to take effect last year.
OPEC, led by Saudi Arabia, has a spotty track record of carrying out production cuts, but compliance has been strong this time. “I think we are where we are because OPEC got their groove back,” said Helima Croft, an analyst at RBC Capital Markets.
The flow of oil to the global market has been further constricted in recent years as a result of the political and economic crisis plaguing Venezuela, another major producer of crude.
The reduced global supply — combined with the solid global economy — has helped push oil prices higher since they fell below $30 a barrel in early 2016. The rising tide has lifted the price of the international bench mark, Brent crude, above $75.
“It is mostly a fundamentals-driven market, but the icing on the cake is the worry about Iran,” said Michael Lynch, president of Strategic Energy and Economic Research, a consulting firm.
A boom in production in the United States has helped offset some of the tightening in supply in recent months. But higher prices elsewhere have prompted U.S. producers to sell on the global market, driving oil exports to record highs and pulling domestic oil prices higher.
That has benefited energy companies, as well as oil-producing states like Texas. Chevron and Royal Dutch Shell recently reported quarterly profits comparable to what they generated four years ago, when prices topped $100 a barrel.
But for large swathes of corporate America, the higher prices mean a hit to profits. Airline stocks fell by more than 1 percent Monday as investors took fuel-price pressures into account.
Likewise, consumer incomes will be pinched by elevated gasoline prices. The national average price for unleaded regular has risen above $2.80 in recent days, according to AAA, and is up roughly 20 percent over the past 12 months. That far outstrips the 2.6 percent year-over-year growth in average hourly earnings through April.
As a larger chunk of workers’ paychecks goes to fuel, less disposable income is left to be spent elsewhere, a potential problem for an economy heavily reliant on consumer spending. Consumer spending slowed sharply in the first quarter, when it inched up at a 1.1 percent annual clip.
Much of that had to do with a slowdown in auto sales after a surge in car-buying in late 2017 to replace vehicles damaged by Hurricane Harvey.
Higher fuel prices could also weigh on auto sales. Low gasoline prices have shifted car purchases heavily toward pickup trucks and SUVs, which tend to be less fuel-efficient than passenger vehicles. Automakers have adjusted their offerings to match the market, with Ford recently announcing it was phasing out the Focus, the Fusion and other sedans from its North American business. Ford’s decision suggests that some carmakers think demand for SUVs and pickups — which are far more profitable — is unlikely to be shifted by any short-term move in gas prices.
“I think you have to get $4 to $5 per gallon before you start having a psychological impact,” said Joseph Amaturo, who covers the automotive industry for Buckingham Research.
Oil companies responded to the price crash that began in 2014 by cutting exploration and other spending and negotiating sharply lower rates from drillers and other contractors, who do much of the work in the oil industry.
As a result, oil and gas projects that are going forward tend to have sharply lower costs than those begun in the $100-a-barrel era. Jessica Uhl, Shell’s chief financial officer, said recently that a U.S. oil field in the Gulf of Mexico that Shell was developing would break even at less than $35 a barrel thanks to a 70 percent reduction in its original projected capital costs. “By applying industry-standard designs, we simplified the scope,” she said.
Lower costs, combined with higher oil prices, are likely to raise profits as long as these conditions hold. Of course, cost inflation may return to the industry, and the cash rolling in may eventually loosen spending discipline, as it did a few years ago.