Saudis Are Going for the Kill But the Oil Market Is Turning Anyway.
Comment of the Day

April 19 2016

Commentary by David Fuller

Saudis Are Going for the Kill But the Oil Market Is Turning Anyway.

The collapse of OPEC talks with Russia over the weekend makes absolutely no difference to the balance of supply and demand in the global oil markets. The putative freeze in crude output was political eyewash.

Hardly any country in the OPEC cartel is capable of producing more oil. Several are failed states, or sliding into political crises. 

Russia is milking a final burst of production before the depleting pre-Soviet wells of Western Siberia go into slow run-off. Sanctions have stymied its efforts to develop new fields or kick-start shale fracking in the Bazhenov basin.  

Saudi Arabia’s hard-nosed decision to break ranks with its Gulf allies at the meeting in Doha - and with every other OPEC country  - punctures any remaining illusion that there is still a regulating structure in global oil industry. It told us that the cartel no longer exists in any meaningful sense. Beyond that it was irrelevant.

Hedge funds were clearly caught off guard by the outcome since net ‘long’ positions on the futures markets were trading at a record high going into the meeting. Brent crude plunged 7pc to $41 a barrel in early Asian trading, but what is more revealing is how quickly prices recovered.

Market dynamics are changing fast. Output is slipping all over the place: in China, Latin America, Kazakhstan, Algeria, the North Sea. The US shale industry has rolled over, though it has taken far longer than the Saudis expected when they first flooded the market in November 2014. The US Energy Department expects total US output to drop to 8.6m barrels per day (b/d) this year from 9.4m last year.

China is filling up the new sites of its strategic petroleum reserves at a record pace. Its oil imports have jumped to 8m b/d this year from 6.7m in 2015, soaking up a large part of the global glut.  Some is rotating back out again as diesel: most is being consumed in China.

Goldman Sachs says the twin effect of rising demand and supply disruptions across the world is bringing the market back into balance, leading  to a “sustainable deficit” as soon as the third quarter. The inflexion point could come sooner than almost anybody expects if a strike this week in Kuwait drags on as oil workers fight pay cuts. The outage is already costing 1.6m b/d.

Kuwait’s woes are the first taste of how difficult it will be for the petro-sheikhdoms to impose austerity measures or threaten the cradle-to-grave social contracts that keep a lid on dissent across the Gulf.

David Fuller's view

While I had seen this article in The Telegraph and was planning to use it, I also received this email from a subscriber today:

I am sure you have read the above. He is saying precisely what you said many moons ago, but the conclusion is I think somewhat different.

Thanks, and yes, he does have a different conclusion which I will comment on below but first here is the article’s headline from the printed edition:

Saudi Arabia’s strategy has killed Opec – the cartel is now irrelevant

OPEC was rapidly losing control, thanks to technology.  However, the Saudis have hastened this process by flooding the market.  This was always going to be a Pyrrhic victory at best and it cut every oil producers’ revenue much more quickly than was necessary.  They could have kept prices at least $30 to $40 higher for the lengthy medium term by making some marginal supply cutbacks, rather than flooding the markets with oil. 

That opportunity was lost, so what happens next?

Here is AE-P’s concluding paragraph:

It never was cheap oil that threatened our economies. The scare earlier this year was misguided. It is the next oil supply crunch we should fear most.

Cheap oil has been a huge bonus for consumers and also corporations which use significant quantities of this fuel.  However, the shale sector was the USA’s fasting growing portion of the economy while oil prices were above $100, but that growth was reversed as crude plunged.  Primarily oil producing countries around the world had considerably sharper reversals, moving from relative prosperity into depression.  This cut off their expenditures with other countries, weakening global GDP growth in the process.  That is what we see today. 

AE-P paints a grim picture of what could now happen in the Middle East, and beyond in terms of primarily oil producing countries.  I would not pay down this risk over the next few years.  However, oil prices are not going back to their highs of a few years ago, in my opinion. 

The world is now less dependent on oil producers, thanks to renewables, new nuclear and natural gas.  US shale producers would quickly increase production as oil prices rose.  Many other countries could do the same, but will they? 

The careless, risky option is to do nothing, while hoping that oil producers will be able to maintain production.  The sensible option is to stockpile cheap crude oil, as China is doing.  Developed countries should also stop closing nuclear power stations for short-term political gains.  They should also invest in new nuclear, although these projects are seldom completed quickly.  More countries should also develop their fracking potential, because we will still need fossil fuels for at least a few more decades.      

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