Record oil production meeting a wave of surprisingly strong demand has reined in world oil prices, creating a delicate balance that could be tipped either way—and the most immediate catalyst may be Iran's nuclear talks.
The market has been awaiting the outcome of the negotiations ahead of a June 30 deadline, as an agreement could put 1 million barrels of Iranian crude back on the market eventually. U.S. crude futures have been locked between $57 and $62 per barrel—since late April.
On Sunday, officials on all sides were quoted as saying the talks would need to continue beyond the deadline. Disagreement was reported to remain on inspections and other key issues.
A preliminary agreement was reached two months ago, but since then it had appeared not enough progress was made. The market had expected an extension.
Should negotiators reach a deal for Iran to end its nuclear program, in addition to the increase in production, Iran could unleash an estimated 30 million to 40 million barrels of oil it now stores on tankers. Oil prices could immediately fall by several dollars if a deal were reached.
"It's a substantial amount of oil. It could potentially move the market out of this range to the upside, or downside," said Michael Cohen, head of energy commodities research at Barclays.
Strategists say there could still be a deal, but later this year. If so, Iranian oil would not hit the market immediately, but traders still anticipate some additional crude from Iran by the end of the year.
The market view has been that a deal would still get done. Yet talk from Iranian hardliners raised doubts about progress last week.
Iran's top negotiator was headed back to Iran sunday to consult with top leadership while U.S. Secretary of State John Kerry rejoined talks this weekend—for the first time in weeks.
"There's a lot of political capital invested at this point in getting a deal," said Cohen. But the pushback has come from both sides. Five former advisors to President Barack Obama sent a letter of concern that the U.S. could fail to reach a "good" agreement and that it risks making concessions that would weaken international inspections, a cornerstone of the earlier agreement.
Earlier this week, Iran's supreme leader, Ayatollah Ali Khamenei, said most sanctions should be lifted even before Iran dismantles nuclear infrastructure or allows international inspectors to verify it is keeping its commitments. He also ruled out freezing nuclear enrichment for as long as a decade and reiterated a refusal to allow military sites to be inspected.
Complicating the situation, Iran's parliament this week passed a bill banning access by International Atomic Energy Agency inspectors to those sites.
Again Capital analyst John Kilduff said if talks actually fell apart altogether, the price of oil could immediately jump $10 a barrel.
"The knee jerk is going to be higher (prices). Also, I would assume relations will deteriorate between the U.S. and Iran, and maybe others, and that will raise the security premium for potential military action that Israel will push for," he said.
A complete breakdown in talks between Iran and the U.S. and five other countries is so far seen as unlikely, but the odds have clearly increased.
Meanwhile, the Iran negotiations are causing barely a ripple in oil prices. The market is so well-supplied that a bombing attack on a mosque in Kuwait on Friday served only to add some support to prices in a weak market.
A surge in crude supply and bingeing by consumers has been keeping U.S. oil futures in the $60-a-barrel area. While strategists see higher prices for crude this year, many see the potential for a dip back into the $50s in the second half of the year if demand drops.
"There's not too much conviction in the market in terms of where we're going, and you have big support to the downside and big resistance to the upside," said Citigroup energy strategist Chris Main. He said also at play were macro factors like Greece, the U.S. dollar and volatility in the Chinese stock market, which plunged another 7 percent Friday.
Citigroup expects WTI to average $61 per barrel in the third quarter, and fall to an average $54 per barrel in the fourth quarter. It forecasts Brent at $68 in the third quarter and $63 in the fourth quarter. Barclays, on the other hand, sees lower prices of $55 per barrel for WTI in the third quarter, and then a $63 per barrel price in the fourth quarter.
Strategists and other experts who answered a CNBC survey this month predicted an average price of $60.81 per barrel for WTI—right in the middle of the current range. West Texas Intermediate crude futures have also held just below the 200-day moving average, at $62.35.
Still, the dynamic that has kept oil prices tightly balanced has surprised many experts, particularly since the new role of the U.S. as an unofficial swing producer had never been tested by low prices before.
Even with the price war launched by OPEC late last year, U.S. shale production has continued to keep U.S. output at 40-year highs—totaling 9.6 million barrels a day last week. Saudi Arabia, meanwhile, on a mission to hold on to market share against non-OPEC producers, like Canada, Brazil and the U.S.—has been producing a near-record 10.2 million barrels a day.
With record oil flooding the market, there have been behavioral changes among some of the biggest customers. For instance, U.S. consumers are buying more gasoline—as much as 300,000 barrels more per day than this time last year.
China appears to have been stockpiling oil this year as prices dropped, and has purchased an estimated 20 to 30 percent more than last year, according to Barclays. At the same time, demand is increasing elsewhere in Asia.
Other factors that could alter the current price picture would be a change in the demand for U.S. gasoline. "The peak is coming in two to three weeks, but the key is growth year on year is still up 200,000 to 300,000 a day," said Main.
But Kilduff said if one thing were to nip the price of oil, it could be the seasonal effect of gasoline sales dropping off. "The only thing holding it up is peak summer demand," he said. Builds in gasoline and diesel supply last week put downward pressure on prices.
"I think what's going to happen, as we get through the Fourth of July, and it gets past peak, you're going to see big builds in crude here," said Kilduff.
Strategists have been waiting for another factor to kick in—an ultimate reduction in U.S. output. The U.S. industry has dramatically reduced its rig count—by more than 60 percent in six months—but production has continued to rise, though perhaps more slowly. there is between 1.5 million to 2 million barrels a day more oil being produced in the world than is currently in demand.
After engineering the OPEC agreement to leave production targets unchanged, Saudi Arabia ramped up its own production, and it shows no sign of cutting back. However during the summer months, it uses more of its output for domestic utility consumption.
Main said Saudi consumption could go to 700,000 barrels a day and drop back to under 200,000 in November or December. If the kingdom was to ease up on production when domestic consumption was peaking, that would could drive oil prices higher.
However, any positive impact that would drive prices to the $65 or higher area would be met with a response. Higher prices would be a catalyst to bring on more U.S. shale production, which has been waiting to return.
"If you get to the levels of $65 or $70, it looks like there's a big appetite for producers hedging from the shale guys which would come in and lock in production at those levels because its economical to run at those levels," said Main, adding that would act as a cap on prices since more oil would then come on to the market.
Main said China's appetite may also be slowing.
"In May, we saw a drop in crude imports. Part of the reason people suggested that was because they were doing less strategic stock building," he said. "That's another reason we could be range bound in the summer."