The oil market is facing a near-term supply deficit, despite the growing cracks in the global economy and stagnant oil demand. At the same time, the market is poised for a major surplus next year.

The combination of the OPEC+ cuts, the worsening supply disruptions in Iran and Venezuela, and a slowdown in U.S. shale have all helped to tighten up balances. The second half of 2019 could see a rather significant pace of inventory drawdowns, erasing some of the glut.

In fact, the degree of uncertainty and risk to global oil supplies is staggering, and the sheer number and volume of production outages around the world would have historically sent oil prices skyrocketing. OPEC is keeping 1.2 million barrels per day (mb/d) offline, Venezuela has lost around 1 mb/d relative to 2017 levels, and Iran’s exports have fallen by more than 2 mb/d since the re-introduction of sanctions last year. Meanwhile, tanker attacks and high tensions in the Persian Gulf put even more supply at risk.

Iran’s oil exports have fallen as low as 450,000 bpd, according to July figures. However, U.S. State Department’s special representative for Iran, Brian Hook, said that the export figure is likely down to about 100,000 bpd, close to the “zero” level that he has been targeting. “We have effectively zeroed out Iran's export of oil,” Hook said during a press briefing in New York. “I can't overstate the significance of this accomplishment.” Harsh U.S. sanctions have effectively blocked Iranian oil exports, but they have also exacted a major human toll on the Iranian population, as the economy suffers and hospitals struggle to find adequate supplies.

The precise oil export numbers offered by Hook differ from other sources, but either way, exports are significantly down from the roughly 2.5 mb/d of exports from early 2018.

Iranian President Hassan Rouhani warned that international waterways “can’t have the same security as before” if Iran’s oil exports were completely forced to zero. “So unilateral pressure against Iran can’t be to their advantage and won’t guarantee their security in the region and the world,” Rouhani added. Related: Hong Kong Billionaire Loses $20 Billion In Canadian Oil Sands

“In the meantime, the short term market balance has been tightened slightly by the reduction in

supply from OPEC countries,” the IEA said in its August Oil Market Report. “If the July level of OPEC crude oil production at 29.7 mb/d is maintained through 2019, the implied stock draw in 2H19 is 0.7 mb/d, helped also by a slower rate of non-OPEC production growth.”

In short, the market is in a situation where supply is already in a state of deficit, and geopolitical risks put even more barrels at risk. And yet, oil prices languish.

That is because even as many analysts see a supply deficit, weak demand seems to keep catching forecasters by surprise. In the first half of 2019, demand only grew by 0.6 mb/d, which was largely the result of the 0.5 mb/d increase in China. In other words, outside of China, oil demand barely grew at all.

U.S. oil inventories fell in the latest EIA release, which seemed to offer some small evidence backing up the notion that the market is in a deficit and will continue to draw down inventories. However, the bullish impact was offset by an increase in gasoline stocks. “The inventory report was tarnished by unexpected increases in oil product stocks: gasoline stocks rose by 312,000 barrels while distillate stocks even grew by 2.6 million barrels,” Commerzbank said in a note. “Gasoline stocks normally fall at this time of year due to high seasonal demand.”

“Just a few weeks before the end of the summer driving season, gasoline stocks are a good 4% up on the long-term average – i.e. at a comfortable level,” Commerzbank added. That has resulted in weaker-than-expected refining margins, which in fact, are at their worst since February.

“Refineries are likely to respond by reducing their processing rate, which had risen again last week. A significant decline can be expected here in the coming weeks. The resulting lower demand from refineries could cause US crude oil stocks to rise again,” Commerzbank said. Related: U.S. To “Drown The World” In Oil

Meanwhile, the slowdown in U.S. shale can be interpreted in different ways. Lower oil prices, financial stress and investor skepticism have forced spending cuts. That has begun to translate into slower growth, contributing to a tighter oil market – or, at least, tighter than things might have been otherwise. In Texas, well completions fell by 12 percent in the first seven months of 2019 compared to the same period a year earlier. Year-on-year production growth slowed to 1.65 mb/d in May, down from a peak of 2.1 mb/d in August 2018.

But production is still growing by quite a lot. “We expect non-OEPC production growth (YOY) of 1.8mb/d for 2019e and 1.9mb/d for 2020. These are very high non-OPEC growth rates in an historical

context, but significantly below the record-high 2.8mb/d growth (YOY) in 2018,” DNB Bank said in a report.

The 1.8 mb/d supply growth from non-OPEC this year stands in sharp contrast to the expected increase in demand of just 0.8 mb/d, according to DNB. OPEC+ cuts have been required to keep the oil market from an utter meltdown, including deeper-than-required cuts from Saudi Arabia, and harsh U.S. sanctions on Venezuela and Iran.

The market may see temporary drawdowns in inventories in the coming months due to extraordinary supply outages, but non-OPEC supply growth and demand grinding to a halt means that the surplus is still set to return in 2020.

By Nick Cunningham of Oilprice.com

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