Will oil become a weapon of choice for Iran?

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(Bloomberg Opinion) – The events in 2019 served as a reminder of how fragile the world's oil supply is, and Iran has typically been blamed for attacks on ships, pipelines, and processing plants in the Middle East. However, in a world that did not seem to know the geopolitics of oil, the effects quickly waned. Now that the United States has killed Qassem Soleimani, the Iranian general who led the Quds Revolutionary Guard, the big question is whether Iran will target oil in its response.

There is no particular reason to believe that Iran’s retaliation against oil will be directed at anything other than that it turns out that even the best-guarded facilities in the industry are vulnerable and the steady flow of oil tankers crossing the Strait of Hormuz , offers numerous possibilities to disturb the oil flow. Around 34 million barrels of crude oil from Saudi Arabia, Iraq and Kuwait passed the channel on their way from the Persian Gulf to US ports last month, according to Bloomberg Tanker Tracking.

Attacks on Saudi Arabia's oil processing operations in Abqaiq and Khurais in September temporarily produced 5.7 million barrels of oil a day offline. This was the biggest supply disorder ever. It was a wake-up call that the world's oil security ceiling – the free production capacity almost exclusively owned by the Kingdom – was nowhere near as secure as was thought.

While the responsibility was claimed by [[Iran-backed]]The Houthi forces in Yemen, which have been at the end of an air bombing campaign led by Saudi Arabia since 2015, blamed the United States and the Saudi directly on Iran. United Nations investigators sent to Saudi Arabia were unable to verify claims by the United States and Saudi Arabia that Iran was behind the strikes. Iran denied being involved.

These attacks caused oil prices to skyrocket for a short time, but the rally was short-lived. A combination of bleak prospects for oil demand and Saudi's swift measures to calm the markets by reducing inventory levels and spare capacity resulted in prices falling below pre-attack levels within a few days.

Now it looks a little different. Oil prices have been on an upward trend since the beginning of October and the assassination of Soleimani has pushed them to their highest level since April.

Although oil demand growth forecasts have not yet improved in the first half of 2020, the promise that a US-China first-phase trade deal will be signed later this month has raised some optimism. In the meantime, the supply side of the balance sheet could narrow, although I'm still skeptical of how much real supply will be withdrawn from the market by the new agreement between the organization of the oil-exporting countries and their large oil-producing partners (collectively referred to as OPEC +).

Saudi Arabia's pledge to cut another 400,000 barrels a day beyond the agreed target would only bring production back to the average level that it has been pumping since March. Russian production of crude oil and condensate, a form of light oil extracted from gas fields, reached an annual post-Soviet high last year. Excluding condensates from the new quota that Russia adjusts to the OPEC countries will help meet the new production target – a quarter of the reduction in crude oil production by the end of December was offset by higher condensate production, according to the country's energy ministry.

The supply-side tightness is more likely to be attributed to the slowdown in US production growth and the potential for further supply losses due to OPEC's Shaky Six. Higher oil prices may have allowed US shale producers to hedge more of their 2020 production. However, this will not necessarily lead to an increase in drilling or supply as investors continue to demand stricter budgetary discipline.

Official US production data for October just released shows that September production increased by 170,000 barrels a day, but is still 90,000 barrels a day lower than the Energy Information Administration had predicted. The ongoing underperformance in the slate area could further limit the offer in the coming months.

This worsening market means that a possible attack on regional oil facilities could have longer-term effects than in September. This is a good reason why the oil markets are nervous.

Contact the author of this story: Julian Lee at jlee1627@bloomberg.net

Contact the editorial team responsible for this story: Melissa Pozsgay at mpozsgay@bloomberg.net

This column does not necessarily reflect the opinion of the editors or Bloomberg LP and their owners.

Julian Lee is an oil strategist for Bloomberg. Previously, he worked as a senior analyst at the Center for Global Energy Studies.

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