ENERGY WATCH #2 - December 20, 2018
With the United States emerging as a ‘buffer’ crude oil producer and consumers marching towards energy efficiency, the cartel is struggling to rediscover its once powerful voice.
Talk of ‘Peak Oil’, or rapid depletion of crude reserves, was all the rage at the turn of the millennium. Oil producers’ underpinning of everything from human mobility to cosmetics, plastics to aviation, put them at the heart of the global economy.
But the theory made two flawed assumptions – first, that emerging technologies could not meaningfully enhance oil production and make hitherto difficult exploration prospects viable, and second, that humankind could not proactively seek alternatives to its crude addiction.
There also existed a feared crude cartel – the Organization of Petroleum Exporting Countries (OPEC) – whose member nations once controlled over 40% of global oil production, and held over 81% of proven global reserves, well capable of spooking the market.
Some in its corridors populated by producers with state-oil giants lapped up the Peak Oil theory, and their own inflated sense of self in a rapidly evolving world to the extent of being blind-sighted by an altering market dynamic. That failing is now being laid bare with the emergence of a major buffer producer, energy efficiencies and the quest for fossil fuel alternatives.
Crude tale of sheikhs versus shale
These days the ‘US Shale Revolution’ is only too visible, but it began in the late 1970s when private American exploration and production independents, set about finding viable methods to tap hydrocarbons trapped in shale rock formations.
Ridicule, failures, hardship and in some cases financial ruin followed, but in the end their ingenuity resulted in the practice of hydraulic fracturing or ‘fracking’, and the concept of horizontal drilling. Process viability and efficiency continued to improve as the industry emerged from a downturn caused by the global financial crisis (2009), all of it under OPEC’s eyes.
As US unconventional output started rising in 2012-13, OPEC first ignored and then dismissed it, before passively acknowledging the “alternative source.” By the summer of 2014, with American oil serving as a drag on three-figure oil prices, the cartel – at the insistence of its heavyweight de facto leader Saudi Arabia – decided to keep its taps open by ramping up production.
The thinking, of then Saudi Oil Minister Ali Al-Naimi, was to have OPEC’s barrels compete with shale barrels and let the market take its course, since US producers were banned from exporting crude oil; a restriction in place since 1975.
But President Barack Obama overturned the ban in 2015, at a time when Washington was importing fewer barrels of OPEC’s oil. By the first quarter of 2016, a full blown oil price slump was in place with the West Texas Intermediate falling below $30 per barrel at one point. Projects were cancelled, investment plummeted, and froth went out of an overheated shale market, yet it wasn’t fatally wounded.
There was hardship around the OPEC table too – especially for the likes of Iran, Venezuela and Nigeria – whose fiscal breakevens demanded $100-plus prices. Something had to give, and the Middle Eastern sheikdoms blinked. Riyadh’s new powerbroker Crown Prince Mohammed Bin Salman packed Al-Naimi off to retirement, replacing him Khalid Al-Falih whose first call at the OPEC table was to ring Moscow.
Dial M for Moscow
By 2016-17, the world’s three largest oil producers were Russia, Saudi Arabia and the US, who were collectively producing more than all OPEC’s 32.5 million barrels per day (bpd), with very divergent political agendas. Al-Falih’s only option was to go beyond OPEC and reach out to the Kremlin, and others.
Al-Naimi described the distrust in vivid detail, labelling cooperation as non-existent or “zero”, even if his successor Al-Falih and Russian counterpart Alexander Novak now appear all smiles on Twitter
Months of wrangling saw 10 non-OPEC producers led by Russia, join hands with OPEC’s then 12, and now 15 members, to announce a production cut of 1.8 million bpd in November 2016. Prices started rising gradually, benefitting among others, none other than the very US shale producers, OPEC was hoping to put out of business.
OPEC also ended up shaking hands with Moscow, striking a partnership with a rival producer, it had historically distrusted. Al-Naimi’s post-retirement autobiography described the distrust in vivid detail, labelling cooperation as non-existent or “zero”, even if his successor Al-Falih and Russian counterpart Alexander Novak now appear all smiles on Twitter.
While compliance with the quota cut averaged above 100% for a time, a very different Twitter account emerged to mess up the works; that of the current White House occupant Donald Trump.
The Donald, discord and Doha
US-Saudi relations mean Washington can always pressure Riyadh over oil. When President George W. Bush saw oil prices as too high in 2007, his preferred mantra was to write letters and call on OPEC to up production via a media sound-bite or two.
But under his watch, the US was the world’s largest importer of crude oil. In 2018, Washington relies less on the global market, and has regained the crown of being the world largest oil producer for the first time since 1973.
In such a setting, whenever the oil price causes even $5 per barrel of political inconvenience, Trump publicly chides OPEC via Twitter, and privately pressurises the Saudis in a way Bush never could.
In the last 12 months Trump has tweeted about OPEC 10 times (and counting) and often when oil ministers’ meetings are in full swing at their Secretariat in Vienna, Austria. While being dismissive in public, the Saudis and their allies do end up accommodating Trump.
In June when the oil price was rising, OPEC said it would put a ‘nominal’ 1 million bpd back into the market. At its recent December summit, while a cut of 1.2 million bpd was announced with Russian-led non-OPEC producers, several producers, including the Russians and Saudis, arrived in Vienna having ramped up their production levels to recent highs, according to data aggregator S&P Global Platts.
Unsurprisingly, as recent oil price declines following the summit suggest, the market is just not convinced. In a matter of days, while promising cuts, the United Arab Emirates announced investment into its oil industry aimed at “boosting production”, while Russia indicated it won’t be able to start the promised cuts (tallying up to 200,000 bpd) before the end of January, and will only get there gradually.
Meanwhile internal discord is boiling up and few at OPEC like the new Saudi-Russian camaraderie. Iran also suspects Riyadh of siding with the US in Trump’s re-imposition of sanctions on Tehran. Timed for maximum impact, Qatar, an OPEC member since 1961, announced it would be quitting the cartel in 2019. Doha’s official line is that it intends to focus on its LNG industry.
Unofficially, a diplomatic boycott instigated against it in 2017 by Saudi Arabia and its allies is thought to be a major contributing factor. Qatar’s decision means it has become the first Middle Eastern nation to quit OPEC. This for an organization that has survived several vitriolic fissures such as the Iran-Iraq war, and Saddam Hussein’s invasion of Kuwait, with all three being OPEC members opting to stay put in their economic interest.
Mediocrity, if not irrelevance, beckons
So low is the market confidence in OPEC that a week before its December 6-7 meeting, the oil price plummeted thrice by over 7% in just 10 sessions.
When the so-called OPEC/non-OPEC cut was unveiled on December 7, the price uptick did not even last into the next week. At the time of writing, oil benchmarks are lurking near 14-month lows.
Traders see OPEC as a house divided and more reliant on non-OPEC producers such as Russia. In volume terms Qatar’s departure matters little. Even including condensates, Doha’s exports touch a mere 1 million bpd, but symbolism matters, as the market looks at internal discord, and strange calls to “institutionalize” its partnership with Russia.
Tectonic plates are shifting with the US tipped to cap 12 million bpd of production in 2019, and over two-thirds of it will come from shale producers. Its light crude exports are incrementally heading to Asia, an OPEC stronghold. The present situation is likely to last for the next 5-7 years, before shale decline rates kick-in. By that time oil demand dynamic might well have materially altered.
Currently, global demand is just shy of 100 million bpd, with growth expectations in 2019 of around 1.2-1.3 million bpd. That’s hardly the stuff of dreams for competing producers. According to the International Energy Agency (IEA), the future of automotive appears increasingly electric, even as internal combustion engines are getting ever more efficient. It means that by 2030, much of oil demand would be predicated on plastics, petrochemicals and aviation.
Demand will still grow, but all players including OPEC members, would be toughing it out in a cramped market. That would make OPEC’s most effective weapon – of upping or cutting production –redundant over the medium term. If it cuts too much, it would risk losing market share and supporting the competition, and if it turns up the volume – a real or perceived glut – would dent all parties.
OPEC still has Saudi Arabia – the world’s only swing producer on its team for comfort – but acknowledges its market share may shrink to 36%, while that of the US will “continue to rise into the late 2020s”. Hence, as the global demand dynamic evolves and supply-side permutations shift, the best OPEC can hope for, short of its dissolution, is mediocrity if not irrelevance.