Traders bet on oil at US$100 as Iran sanctions loom

A worker passes stores of seamless steel pipes for use in oil and gas pipelines in a storage area at the Volzhsky Pipe Plant OJSC, operated by TMK PJSC, in Volzhsky, Russia. (Bloomberg pic)

NEW YORK/LONDON: Oil traders have piled into wagers that US crude oil could surge to US$100 (RM414) a barrel by next year, a milestone that until recently many considered unthinkable due to record US production growth and relatively flat global demand.

But the imminent return of US sanctions on Iran and bottlenecks keeping US oil from getting to market have fueled a rally that has taken benchmark oil prices to four-year highs.

While big producing nations say supply is ample, hedge funds and speculators are increasingly skeptical of that argument, betting the market could rally further as sanctions on Iran’s crude exports return on Nov 4.

The bullishness is visible in the US options market. The number of open positions on US$100 December 2019 WTI call options – bets on futures hitting that price by the end of 2019 – has risen by 30% in the last week to a record 31,000 lots, according to CME data.

“Over the last two weeks, there’s been a lot more evidence that even some of the larger customers – India and China – are not going to be buying Iranian crude from November,” said John Saucer, vice president of research and analysis at Mobius Risk Group.

As a result, he said, “these sanctions are likely to be a lot more effective than people even thought.”

Overall exports from Iran have dropped to 2 million barrels per day (bpd) in September from 2.8 million bpd in April, the Institute of International Finance said.

Estimates for how much of Iran’s exports could be affected range from 500,000 bpd to 2 million bpd, and uncertainty over the impact could ultimately foster price swings in either direction.

Brent crude, the international benchmark, rose above US$86 a barrel on Wednesday, and US West Texas Intermediate (WTI) US crude hit US$76 a barrel, both four-year highs.

The Trump administration’s decision to renew sanctions on Iran prompted a sharp shift from the Organization of the Petroleum Exporting Countries. After about 18 months of restraining supply, Opec agreed to increase output.

Further, Saudi Arabia and Russia recently agreed privately to boost supply before telling other Opec countries in an effort to mollify US President Donald Trump, who has focused his anger on rising prices.

Oil markets are looking to Opec and Russia to make up shortfalls in supply. US production, which sits at a record 11.1 million bpd, cannot replace Middle East crudes, such as Iranian grades, in Asian refineries. In addition, transportation bottlenecks are constraining US output.

“We continue to see price risks tilted to the upside and do not rule out a spike in oil prices to US$100/barrel,” UBS analyst Giovanni Staunovo said.

Open interest in US$100 December 2018 Brent call options , which expire in late October, is currently more than 50,000 lots, more than any other strike price for that month, according to InterContinental Exchange data.

Implied volatility for very bullish Brent options that expire after the Nov 4 resumption of sanctions has overtaken that for very bearish options, suggesting increased demand for such bullish bets.

This spread, or skew, is at its most bullish since mid July.

Open interest in US$100 December 2018 WTI calls, which expire in mid-November, has risen to the highest in over four months at about 15,000 lots.

Many traders said these US$100 bets face long odds. Option contracts used to speculate on far-fetched outcomes tend to be cheap, and if crude’s rally stalls, those positions will expire worthless. But even a short-term jump could make those options more expensive, and holders could sell them for a profit.