Battle of the Barrels will keep pressure on oil prices

Last Wednesday the price of the Opec basket of member country crudes (which includes the UAE’s Murban) closed at $29.71 per barrel. According to the Opec secretariat, it then plunged to $27.85 the next day.

In the past, penetration of an important milestone like $30 per barrel on the Opec marker price would have brought calls from several members for an emergency Opec meeting to stabilise the market. Instead oil ministers were silent.

The Opec price news was not even reported in the wire services, as the media focused on the war of words and proxy conflicts between Saudi Arabia and Iran.

Riyadh would probably veto any emergency session, both for political and economic reasons as it seeks to regain market share. Strangely, Iran seems now to have the same stance, whereas before it habitually called for extraordinary meetings and production cuts.

Regaining market share is now at the top of Tehran’s list of priorities. At the December Opec meeting, the Iranian petroleum minister Bijan Zangeneh made it clear he would not sign up to anything until he had restored as much production as possible after the imminent lifting of the international sanctions, a reward for Iranian compliance with the IAEA nuclear agreement.

The sanctions reduced Iranian exports from 3 million bpd in 2011 to around 1.6 million bpd in 2014 and 2015. On Thursday the US secretary of state John Kerry said the nuclear agreement would be implemented this month, triggering the automatic lifting of the oil sanctions.

Mr Zangeneh has repeatedly indicated he can immediately add 500,000 bpd, and possibly another 500,000 bpd by mid-year. Many of these barrels are in Iranian tankers already delivered to markets.

He previously suggested new supplies would be added to markets judiciously, but that was before the diplomatic spat over the Saudi execution of the senior Shia cleric Nimr Al Nimr.

Now all bets on an orderly transition are off. After spiking up 5 per cent initially on fears the political strife might escalate, the market fell sharply last week, once it recognised that the Saudi-Iran flare-up decreases close to zero the chance of any accord, perhaps even at the scheduled June Opec meeting.

Crashing stock markets around the world also played their part in the oil price rout. But here too the Saudi-Iran quarrels in Yemen, Syria, Bahrain and Iraq have negative implications for the oil market. In 2009, Opec agreed to production cuts to offset the weakness occasioned by the world financial crisis and oil prices recovered after crashing to $30.

If the past week deepens into another financial crisis, there is little chance of cooperation to stabilise the market this time around. The outlook for oil prices in 2016 is therefore very bleak.

When Opec adopted its market share policy in November 2014, some members thought it would be “short-term pain for long-term gain”. However non-Opec production has so far proved surprisingly resilient, compared with initial expectations.

In fact the Opec secretariat gave its members a lump of coal just before Christmas when the 2015 World Oil Outlook projected that the 2020 call on Opec oil would be only 30.7 million bpd, a full 1 million bpd below current output. The forecast expected a world of further gains for shale and tight formations as US shale success moves to Russia, Argentina and other areas.

The Opec projections are predicated on average Opec basket prices moving from $60 per barrel in 2016 to $80 per barrel in 2020.

Clearly these are heroic assumptions and it is likely that non-Opec production will be much weaker if the market is savaged by excess supply for a sustained period.

Yet bitter experience and the Outlook forecast appear to have steeled Saudi Arabia and other Gulf producers in their determination to press on with the focus on expanding market share.

Prices will have to remain “lower for longer” if shale producers are to be dislodged from the niches they occupied when prices were above $100 per barrel. And additions to Saudi output will only come slowly with initial Opec market share gains being claimed by Iran, Iraq, and African light crude producers displaced from the market by US shales from which only light grades can be extracted.

At the end of December the Russian minister of energy Alexander Novak accused Saudi Arabia of destabilising the world oil market by adding 1.5 million bpd over the past year. Riyadh would indeed be celebrating if this were the case.

Both the International Energy Agency and the Opec Monthly Oil Market Report agree that Saudi Arabia output has risen only just over 500,000 barrels per day, compared with the average for 2014.

Furthermore, if higher Saudi consumption is taken into account, the gain in net exports is only 200,000 bpd.

Historically, Saudi net exports of about 7.9 million bpd are still well below their 9.5 million bpd peak in 1980.

The Russians are upset because Riyadh is taking traditional Russian markets in Europe, to make up for Saudi oil being displaced from Asia by Iraq and other Gulf producers (including the UAE) whose total output has mounted by about 1.2 million bpd, compared with the average for 2014.

Russia, Saudi Arabia and Iran all have perceived grievances which mitigate against compromise.

With the heavyweight producers all pressing more into a market already oversupplied by up to 2 million bpd, it is clear “the Battle of the Barrels” will keep oil prices under pressure for a long time to come.

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