30-05-2016

OPEC forced to accept new reality on oil prices

opec

Although oil prices briefly went above US$50 per barrel this past week, the forthcoming Opec meeting in Vienna on Thursday will provide no support for those who hope the organisation will finalise the production freeze that Saudi Arabia rejected in Doha.

That decision came during the April emergency session convened to consider a Russian initiative to limit production increases.

The kingdom’s policy under new energy minister Khalid Al Falih remains focused on increasing its share of the world oil market and leaving prices to free competition.

But neither has Riyadh dumped new supplies on the market during the difficult time while Iran is boosting its exports after the lifting of the UN sanctions as a result of the nuclear deal with Tehran. Saudi Arabia could easily boost output significantly with its 1.5 million bpd excess capacity.

While shorter term it has not added fuel to the price war fire that forced barrels into the $20s earlier this year, there can be no doubt about its determination to boost its capacity and add supply whenever higher cost producers are forced out of the market.

In contrast to collapsing international drilling levels offshore and in the US shale production frame, Saudi Arabia has increased its drilling and is busier than ever in boosting its reserves of both oil and natural gas. Ironically, it appears that the kingdom may have the richest shales in the world and a policy priority of Saudi Aramco is increasing natural gas production which will replace the burning of heavy crude oil now used in electricity generation.

Longer term this will make more Saudi crude available for export and reduce the huge subsidy on electricity under which heavy oil is priced at around $2 per barrel for generation purposes. Electricity generation has also been reorganised under the purview of the new energy minister, where previously it has been a separate ministry which lobbied for underpriced crude.

The reorganisation will facilitate the rationalisation of the Saudi energy sector which Mr Al Falih had been pursuing as head of Saudi Aramco. He has the strong support of the influential deputy crown prince, Prince Mohammed bin Salman, who is determined to restructure the whole economy along more liberal lines, which would reduce costly subsidies and attempt to diversify new growth away from oil.

But the reorientation of the Saudi economy will be financed largely from oil revenues and there is clearly a concern that a large proportion of Saudi reserves, which some experts and the former Saudi energy minister Ali Al Naimi put as high as 1 trillion barrels, will be left in the ground.

Prince Mohammed has stated that Saudi capacity could be pushed to 20 million barrels per day, indicating a different mindset from the leaders who prevented Aramco from lifting capacity to the 24 million bpd which had been contemplated in the 1970s when American supermajors controlled the company.

Long-term expansion of Saudi capacity is a reality which will challenge the oil market and put paid to previous notions that the top Opec objective is to stabilise the market at some “fair price” for crude oil. Other Arabian Gulf countries are also seeking to increase production capacity.

The UAE objective of raising capacity from 2.8 million to 3.5 million bpd and selling more oil remains intact, even if this might take a year longer under the new price reality. Kuwait, too, is pressing on with its programme to raise output by 500,000 bpd and Qatar is also looking to sell extra barrels to make up for the drop in price.

Meanwhile Iraq, which has boosted exports more than any other Opec country, presses ahead with its field rehabilitation plans, even if the major oil companies carrying out the recommissioning of old fields have cut their spending in half because of payment delays resulting from the reallocation of money towards military expenditure aimed at expelling ISIL from its strongholds in Iraq.

The wildcard in the new race for oil production capacity is Iran. Although the government, like Iraq, aims to expand through field rehabilitation now that the UN sanctions have been lifted, it remains unclear the pace at which this can be accomplished under continuing US financial sanctions and a reluctance of western companies to return to Iraq in case the UN sanctions on exports are re-imposed because of non-compliance with the nuclear deal.

But longer term, there seems to be a determination to bring huge Iranian reserves back into the market, in contrast with the previous policy of restricting production to maximise price. Around the Gulf this all adds up to many extra barrels being produced and it is clear the centre of gravity of the world oil market will shift towards the region.

This reality will weigh heavily in the background at the Opec meeting. While Iran may call for production restraint (itself excepted of course), the prevailing orthodoxy has clearly shifted from stabilising price to restoring market share.

The sea change in Gulf thinking was clearly illustrated at an oil conference in Kuwait this past week.

There the former long-standing Qatari minister of energy and industry, Abdullah bin Hamad Al Attiyah, said that the rise of shale production would lead to the loss of Opec market share if the organisation pursued its previous priority of market stability.

Therefore the organisation has no choice but to abandon attempts to balance the market and focus on producing reserves.

On the surface this is an astonishing volte face for the previous Opec president, who was a prominent member of the group’s quota monitoring committee which restrained production to maintain a target price. But between the lines it can be read as an acceptance of the new reality where actual production is interpreted as troops on the ground in the battle for oil market share.

It perhaps may not be regarded as surprising from the man who built the Qatari success story by hugely expanding natural gas and NGLs productions while he was in office.

If Opec is embracing an oil version of this philosophy, it will become evident at the meeting on Thursday.

Some say the new reality is a death knell for Opec, but it could as easily be a new beginning if the organisation simply converts to the new Gulf orthodoxy of maximising market share instead of price.

Source: The National

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