Tag: OPEC

New OPEC Deal Puts Saudi Arabia On The Sidelines

The new OPEC deal to cut oil output, the Cartel’s first since 2008, gives OPEC what it wanted: higher oil prices. It was difficult for the Cartel to achieve an agreement. Russia, a major oil producer that isn’t even a member of OPEC, brokered a deal between Saudi Arabia and Iran. From Oil Price:

The interventions ahead of Wednesday’s OPEC meeting came…from Putin, Saudi Deputy Crown Prince Mohammed bin Salman and Iran’s Supreme Leader Ayatollah Ali Khamenei and President Hassan Rouhani…According to Reuters, Putin’s role as intermediary between Riyadh and Tehran was pivotal, and is a “testament to the rising influence of Russia in the Middle East since its military intervention in the Syrian civil war just over a year ago.”

Prior OPEC meetings failed to deliver consensus, because nobody wanted to cut production. Tehran argued OPEC should not prevent it from restoring the output lost by years of Western sanctions, but the Saudis wouldn’t agree. The animosity between them didn’t help: Proxy wars in Syria and Yemen have exacerbated decades of tension between the Saudi Sunni kingdom and the Iranian Shi’ite Islamic republic.

The brokering started when Putin met Saudi’s Prince Mohammed on the sidelines of the G20 meeting in China. Both felt they could benefit from cooperating to push oil prices higher, and agreed to work together to cut excess production that had more than halved oil prices since 2014. Lower prices had created large budget deficits for both Russia and Saudi Arabia.

Financial pain made cooperation possible, despite the huge political differences between Russia and Saudi Arabia over the civil war in Syria. But Iran also had to agree. Prince Mohammed had repeatedly demanded that Iran participate in any production cuts. Saudi and Iranian OPEC negotiators had debated the point without compromise for months.

Putin stepped in: He established that the Saudis would shoulder the lion’s share of cuts, as long as Riyadh wasn’t seen as making concessions to Iran. A deal was possible if Iran didn’t celebrate a victory over the Saudis.

Reuters reports that a phone call between Putin and Iranian President Rouhani smoothed the way. After the call, Rouhani and oil minister Bijan Zanganeh went to Iran’s supreme leader for approval. During the meeting, leader Khamenei approved the deal. He also agreed that Iran wouldn’t take a victory lap once the deal was announced.

And so the deal got done. OPEC is trimming output by 1.2m barrels per day (bpd) starting January 1st.

The deal is contingent on securing the agreement of non-OPEC producers to lower production by 600,000m barrels per day. Russia says it will contribute half of that, 300,000 bpd. Iran was allowed to slightly boost its output, while Iraq slightly lowered theirs.

We’ll see if the deal holds, and/or, who cheats.

Pundits like to chalk up winners and losers in this type of deal. Since OPEC now accounts for less than half of all energy output in the world, it is a weakened cartel, dependent on the kindness of outsiders (like Russia) to hold together.

Saudi Arabia looks like the biggest loser. First, it cut production by 500,000 bpd. Second, it has presided over a momentous shift in global power, one that is as stunning as Brexit or Trump’s victory.

Saudi’s capitulation to Russia and Iran ends OPEC’s domination of the world’s energy market. The Saudis also made the US shale oil market more powerful in the global energy market, since US shale will produce more oil whenever oil prices are high. However, Saudi oil remains far cheaper to produce than American shale oil, since it requires far less energy to extract and refine.

Russia emerged as the biggest winner. Its economy did not buckle under the Saudi effort to drive oil prices down via increased production. Putin is now the indispensable power broker in the Middle East, something that was unthinkable even 12 months ago. The Syrian civil war will soon end with Russia winning, Assad staying in power, and Saudi Arabia as the regional loser.

And so, this year truly has seen the death of one world order, along with the birth of another. The US and Saudi now have very little to show for their 50+ year joint effort to dominate the Middle East. The EU looks far from stable as a force in Western Europe.

And Saudi Arabia has just become the third dinosaur to be felled by the asteroid called 2016.

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Oil: Our Latest Middle East Bombing Run?

Oil has now become another front in the competition between America’s friends and enemies in the Middle East. On October 1st Saudi Arabia, the OPEC cartel’s dominant producer, pumping around a third of OPEC’s oil, or about 9.7 million barrels a day, unilaterally cut its official prices. The Economist reports on the surprising price of oil:

Since June the price of a barrel of Brent crude oil—the global benchmark—has slumped from $115 to $92, a decline of 20%, and the lowest for more than two years.

Here is the Economist’s  graph of Brent crude prices:

Brent Crude Price

They report that the drop is partly due to economic weakness. Growth is slowing, particularly in China and the Euro zone, bringing with it a reduction of oil consumption. The WaPo reports that prices have fallen in the US as well: (brackets by the Wrongologist)

Crude oil prices are…down to the lowest level in 17 months in the US. Gasoline prices have [also] been sliding.

Reuters reports that Saudi Arabia told the oil market it would be comfortable with prices as low as $80/barrel for a period of up to two years. Reuters says the following about the Saudi strategy: (emphasis by the Wrongologist)

The Saudis appear to be betting lower prices – which could strain the finances of some members of OPEC – will be necessary to pave the way for higher revenue in the medium term, by curbing new investment and further increases in supply from places like the US shale patch…

This drop in prices will give a short-term boost to the US economy and US consumers, who will view cheaper gas prices like an increase in take-home pay. But it could put a dent in revenues in countries such as Russia, and Iran, where oil exports play an enormously important role in supporting economic growth and government finances. Russia’s Finance Minister has already announced that lower oil revenues could force the curtailment of its military spending:

Between 2004 and 2014, Russia doubled its military spending and according to the newly adopted budget, it will further increase it from 17.6 percent of all budget spending this year to 20.8 percent, or 3.36 trillion rubles ($84.19 billion), in 2017.

But the new Russian budget, which envisages a deficit of 0.6% of GDP over the next three years, is based on oil prices of $100+ per barrel, not the high-$80’s seen this week. On Monday, President Putin signed a law that would allow the government to tap one of the country’s oil windfall revenue funds, the Reserve Fund, for the first time since the aftermath of the 2007-8 global financial crisis. The Fund contains $90 billion. While it is doubtful that this will change Russia’s stance on Ukraine, it might influence Russia’s position on Syria.

The Wall Street Journal reports that Iran has a higher per barrel break-even price than other Middle East oil producers. Here is the oil per barrel price required to balance each country’s budget:

OPEC Breakeven prices

 

Iran, faced with lower oil revenues and the highest break-even price, could be forced to limit its nuclear program, or even its support for Iraq’s battle against ISIS.

But before we have a party and celebrate, lower prices also affect oil production in the US. The Economist quotes David Vaucher, an analyst at IHS, who says that to achieve a realistic internal rate of return on investment of 10%, a typical new shale-oil project in America requires an oil price of $57 a barrel, but some still require between $75 and $110.

The Obama administration held detailed discussions in September with the Kingdom of Saudi Arabia. While it was clear that one outcome was an agreement by the Saudis to participate in air attacks on ISIS, it is clearly possible that the plan to use oil prices as a tool in the fight was also on the table. It wouldn’t be the first time that oil price (or availability) has been used as a weapon. Oil was first used as a weapon by the US to stop Israel, Britain, and France from retaking the Suez Canal in 1956.

And as Michael Klare says at Oilprice.com, the “oil weapon” was used in 1973 against the US. We hated OPEC’s war on our economy back then. Skip ahead four decades, and it’s smart, it’s effective, and it’s the American way. We of course, used that very same old oil weapon when we embargoed oil sales by Saddam Hussein’s Iraq.

Oil is again the centerpiece of our Middle East strategy.

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