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Oil prices poised to spike as supply from Iran declines ahead of US sanctions

Crude oil prices are poised for a rally as Iranian oil production has already started to decline faster than many had anticipated ahead of the reinstatement of secondary sanctions by the United States.

In early May, U.S. President Donald Trump announced the U.S. would withdraw from the 2015 Iran nuclear pact, and economic sanctions suspended under the deal would resume. Sanctions impacting the oil sector will begin in November.

Worries that the Iran sanctions would tighten supply prompted OPEC and its 10 allies to agree June 23 to reduce over-compliance with their cut and increase output by 1 MMbbl/d in the coming months.

But Iranian production has started to suffer ahead of the sanctions, falling to 3.50 MMbbl/d in August, the lowest level in more than two years, according to a Platts survey.

Third-party ship tracking data indicates that countries such as China and India have already reduced their purchases of Iranian crude. The U.S. Energy Information Administration said in its latest Short-term Energy Outlook released Sept. 11 that it estimates waterborne crude oil exports from Iran in August dropped 200,000 barrels per day on the month and were down almost 20% from the year-to-date average.

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"We are reducing our 2019 Iranian oil supply estimates by 500,000 bpd. Put another way, we are raising our assumed 2019 Iranian sanction-related supply reductions/interruptions to 700,000 bpd from our previous estimate of 200,000 bpd," analysts from Raymond James wrote in a Sept. 10 research note. "This now represents the largest annual production decline from a single country over the next year."

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In 2019, Iranian production is expected to average 3.1 million barrels per day, down from 3.8 MMbbl/d this year. Iran's production is seen averaging 3.2 MMbbl/d in 2020. On top of the reduced supply due to the Iranian sanctions, supply is likely to tighten further, by as much as 900,000 bbl/d in 2020, with IMO 2020 going into effect as the global refining and maritime shipping industries prepare for more strict regulations on the sulfur content of marine fuels.

Amid other supply disruptions in August, total global petroleum inventories declined by almost 400,000 bbl/d during the month, the seventh consecutive month of net inventory withdrawals, the EIA added.

Apart from the decline in Iranian exports, production from Venezuela has been impacted for quite some time due to ongoing economic and political strife in the country. "If Venezuelan and Iranian exports do continue to fall, markets could tighten and oil prices could rise without offsetting production increases from elsewhere," the International Energy Administration said in its Sept. 13 monthly market report.

Reports of the reduced purchases of Iranian crude ahead of the November sanctions have already been working to boost oil futures prices since the end of August.

"Apparent hedging activity in the crude oil options market suggests several market participants purchased financial protection in anticipation of an increase in crude oil prices ahead of the November implementation of Iranian sanctions," the EIA said. "If the reduction in Iranian crude oil production and exports is larger than expected, the disruption to the crude oil market in the fourth quarter of 2018 could result in price increases."

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Analysts are also bullish in terms of the impact of tightening supply on Brent and West Texas Intermediate crude prices.

"I think this [the Iran sanctions] is the event that will tighten supply and drive oil [futures] back above $80/bbl, even though I think we were heading there anyway," Price Group energy analyst Phil Flynn said in a Sept. 10 email. "We could lose 1.5 to 2 MMbpd, and it's not clear that the oil can be made up easily. The problem is spare production capacity is historically low. There is no room for error."

"While global supply versus demand is in a delicate balance, we feel that we are headed towards a deficit may be as early as next year. While our target on oil for this year remains at $84 a barrel in 2019, you should be able to add $10 a barrel to that price," Flynn wrote in a Sept. 13 research note to clients.

"We are entering a very crucial period for the oil market. The situation in Venezuela could deteriorate even faster, strife could return to Libya and the 53 days to November 4 will reveal more decisions taken by countries and companies with respect to Iranian oil purchases. It remains to be seen if other producers decide to increase their production. The price range for Brent of $70-$80/bbl in place since April could be tested. Things are tightening up," the IEA said.