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The Oil Market Is Entering a “Crucial Period”

Matthew DiLallo, The Motley Fool

The oil market is in a state of flux. While demand continues to grow at a brisk pace, supplies hit a record 100 million barrels per day (BPD) in August, according to the latest oil market report from the International Energy Agency (IEA). That's after Iraq delivered record-setting production while supplies from Libya rebounded. Because of that, there was more than enough oil to meet the market's needs. 

However, the IEA noted a few concerns in its report, which suggested that the oil market could tighten up in the coming months and push crude even higher than its current perch near $80 a barrel for Brent, which is the global oil benchmark. That led the IEA to conclude that the oil market is entering a "crucial period," since it's unclear whether other producers will be able to pick up the slack. If they can't, then oil could head even higher.

Pump jack backlit by the setting sun after the rain.

Image source: Getty Images.

Drilling down into the current situation

While global oil supplies topped the 100-million-BPD mark in August, there's some concern about whether producers can keep up that pace. First of all, output in Venezuela remains in free fall. The IEA noted that production averaged 1.24 million BPD last month and could slip to 1 million BPD by year-end if it continues its current rate of decline. That's a steep drop for a country that produced an average of 2.5 million BPD in the last decade. It's not as if Venezuela is running out of oil since it holds the largest reserves in OPEC. Instead, the country doesn't have the money to invest in maintaining its production due to its current economic problems.

Meanwhile, oil exports from Iran have started falling in anticipation of the sanctions on that country levied by the Trump administration, which go into effect in early November. So far, Iran's exports are on pace to decline by 500,000 BPD. However, they could potentially fall by as much as 2.5 million BPD, according to some analysts.

While OPEC does have about 2.7 million BPD of spare capacity to help fill in the gaps, "it is not clear exactly how much, beyond what is widely thought to be 'easy' to bring online, will be available to coincide with further falls in Venezuelan exports and a maximization of Iranian sanctions," according to the IEA. The IEA further notes that "if we are looking for additional barrels from elsewhere to help compensate for further export declines from Venezuela and Iran the picture is mixed." That's because output from Brazil hasn't increased as much as expected this year due to a variety of issues. Meanwhile, pipeline constraints are slowing production growth in the Permian Basin, which had been the fastest-growing oil region in the world. That issue likely won't abate until the end of next year when new pipelines should enter service.

An oil worker with a laptop near an oil pump.

Image source: Getty Images.

What this means for the oil market

These factors led the IEA to conclude that "we are entering a very crucial period for the oil market." Not only could the situation in Venezuela deteriorate at a faster pace given its economic issues, but strife could return to Libya and knock some of its output back offline, while the deadline on Iran is just around the corner. Because of that, the price range of $70 to $80 a barrel for Brent "could be tested" since "things are tightening up."

While higher oil prices would be bad for oil consumers, it would benefit oil producers, especially those that can capture Brent-based prices, which are currently $10 a barrel more than the U.S. oil benchmark West Texas Intermediate (WTI). Multinational oil companies like ConocoPhillips (NYSE: COP) and Chevron (NYSE: CVX) would be among those that benefit the most. In ConocoPhillips' case, every $1-per-barrel change in the price of Brent would boost its cash flow by $105 million to $125 million during the course of a year, whereas that same increase would only improve its WTI-based cash flows by $45 million to $55 million. Meanwhile, Chevron produces an average of 575,000 BPD of oil and other liquids in the U.S. that fetch WTI-based prices while getting nearly 1.2 million BPD from places that capture Brent pricing. Because of their higher weighting toward Brent, Chevron and ConocoPhillips would earn more money per barrel if global oil prices rise in the wake of supply problems in Venezuela and Iran.

Global oil producers could emerge as the winners

The oil market could be very volatile over the next few months. If production from Venezuela continues plummeting and supplies from Iran slump due to sanctions, then the price of Brent could blast well past $80 a barrel. That would be great news for oil producers like ConocoPhillips and Chevron, since they sell a larger portion of their oil at Brent-based prices, which could give their stocks more fuel to outperform rivals in the coming months.

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Matthew DiLallo owns shares of ConocoPhillips. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.