War hits the international oil market: Who will be the victim of US – OPEC dispute?

As the US have become important oil producer, within a context where the demand is under huge pressures deriving from the negative evolutions of the economies of China and Europe, this has led to the fall of oil price down to USD 80 per barrel. It is the core of a war between the OPEC countries and the US and the oil price evolution radically changes the countries’ status on the international market, with effects in another part of the world, in Russia. As any other war, this one has winners and losers: on one side there are the countries depending on oil exports, on the other side the ones which see the price reduction for energy as a chance to re-launch their economies. But even for them the advantages of cheaper oil come with a series of potential risks.

The global higher output, combined with the cut in demand from China and Europe, have driven the international oil price to USD 80 per barrel for the third time during the latest four years – the lowest level in this interval.

Following the steep fall in prices registered lately, the ‘Short-Term Energy Outlook’ report issued by the Energy Information Agency (EIA – Agency of the US State Department) by the end of September pointed to the fact that the average price for WTI oil this year is estimated to go down against the former anticipations (released in August) from USD 100.45 per barrel to USD 98.28 per barrel; concomitantly, the average price of Brent oil for this year is estimated to go down from USD 108.11 per barrel – as envisaged in August – to USD 106 per barrel. The sharp fall of oil price (some 20 percent) during the latest several months are due to change the prognosis for 2015 too. According to the quoted EIA report, the West Texas Intermediate (WTI) oil price will have in 2015 an average price of USD 94.67 per barrel; the estimation is much more pessimistic than the one issued in August which was pointing to USD 96.08 per barrel. At the same time, the same EIA report has reduced the anticipations for Brent oil for next year from USD 105 in August to USD 103 per barrel. These are just some of the data that have already sent a shock wave throughout the world, causing major and sometimes unexpected changes in the behaviour of the main players on the market. From the statistic point of view the drop in oil price is not essentially unexpected within a context of low demand; however, a 20 percent correction in only several months, during which the tensions in the Middle East are at high levels and while some of the big oil suppliers, such as Syria, Iraq and Libya are practically fighting wars (endangering the continuity of supply) is a sign the pattern by which the international oil market has worked during the latest years is changing. A worrying change for the dominant players, as it is a menace against their status within the system.

FALLING DEMAND

The threats are the more serious as the changing trend is following several channels, and the system’s modifications are complex and hard to counteract. One first driver of this tendency is the fact that the energy demand in general, at the global level, is getting tempered every year; this is a consequence, on one hand, of the consumers’ significant increase of energy efficiency (at world level – but mainly by the developed economies) and by the increase of alternative energy ratio in the demand; on the other hand it is influenced by the global crisis, the demand being lately under more pressure due to the fall of oil demand in China (an economy with a considerably lower growth rate) and by the negative prospects of an Europe unable to get out of the crisis.

re-launching-the-us-oil-productionBeyond the pressure coming from the above mentioned issues, the main vector determining the oil price decrease is that the US has become, from a major energy importer, one of the most important players on the offer side. The oil price has been practically pushed back to the USD 80 per barrel level by the US repositioning on the oil world market and by the reaction of the traditional producers. Following decades of dependency on imported oil, the boom of shale output lifts the US’s oil production by 65 percent higher as compared to the one five years ago, while the imports were cut by some 3.1 million barrels against the peak in 2005. Anticipations regarding the future are in accordance with the dynamics registered by the statistics on former evolutions: the EIA prognosis by mid October revealed the US are to reach, by the end of the year, an annual average output of some 8.54 million barrels per day (much higher than the average registered last year of 7.45 million barrels per day); for 2015 the average daily output is estimated to increase by 11 percent up to 9.5 million barrels per day, as the US oil production is to reach again the maximum level registered during the ‘70s (see the chart ‘Re-launching the US oil production’).

THE US REPOSITIONING

In fact, according to the data contained in the “World Oil and Gas Review 2014” study released by ENI, (one of the main players in the field) the US output had already surpassed the level of 10 million barrels per day at the end of 2013 (see the chart ‘Top 10 oil producers at world level’; it needs to be mentioned that the statistics include the oil output and other liquid hydrocarbons such as natural gas).

top-10-oil-producers-at-world-levelIrrespective of these data, the obvious trend shows that the US oil output increase and the cut in imports have left traditional producers with a major oil surplus; through that America has decisively influenced the total supply. The US influence on the international oil market is even better revealed by the fact that, while the oil price is dropping, a significant cut is noticed in the gap between the Brent oil prices (the benchmark for the European market) and the WTI oil prices (benchmark for the American market); this is one of the clues showing that the main cause for oil prices decrease is determined by the increased offer of WTI oil – the one coming from the American market. As during the last decade the Brent oil had been traded by some USD 20 per barrel above the WTI oil, currently the gap is significantly down: e.g. by mid October the gap was of only USD 5 per barrel in favour for Brent oil. Concluding, the US pressure on the international oil market is huge. Such pressures on the markets and against the current global status are amplified by the upward trend registered by the oil reserves, in spite of pessimistic anticipations: as such, the same ENI report (“World Oil and Gas Review 2014”) shows that during the latest 13 years the world oil reserves have grown by 36 percent (or at an annual growth rate of 2.5 percent, as can be seen in the chart ‘Top 10 countries - world oil reserves’), from 1.21 trillion barrels in the 2000’s to some 1.66 trillion barrels by the end of 2013.

THE OPEC SURPRISE

Such developments are obvious not only in the EIA statistics, but also in the calculus, the prognosis and the anticipations the players on the market make; all traditional oil producers are aware that, in order to meet the new challenges on the market, they need to fight for their market share. Thus, during the latest months – from Russia to Venezuela, from China to the Middle East or from the regions ‘on fire’ such as Iraq and Iran, up to the comfortable offices in Washington or European capitals, to the transactions’ monitors – the investors, the governmental officials, the big state or private companies’ representatives and the analysts have followed closely the quotations on the commodity markets, waiting for the OPEC intervention. The OPEC is the institution responsible for some 40 percent of the global oil output, which traditionally acts as the highest regulator of the oil price, demand and offer, by reducing or increasing the output.

top-10-countries-world-oil-reservesStatements from the OPEC officials have not yet to be released! The member states failed to reach a common stand and to release a joint public answer. Yet, despite an official position not being released, OPEC has already intervened! However, it was an intervention contrary to the ones adopted during similar intervals of falling prices and contrary to the players’ expectations: instead of decreasing the output (and the offer) OPEC extracted higher amounts of oil! According to the EIA data, by September the members’ output reached 30.47 million barrels per day, the highest level in the latest 13 months.

As important as the above mentioned trends, or even more important, are the statements made by some of the member states’ officials; most relevant are those of the cartel’s dominant members. In this regard, the specialists of the International Energy Agency (IEA – international organisation with offices in Vienna) opine that the Saudi Arabia’s and Kuwait’s approaches (the first and the third main oil producers within OPEC) is a mean of pressure on the future price of oil – although it does not reveal any clues on taking into consideration the output decrease.

By mid October, according to the Saudi press agency Kuna and quoted by Reuters, Ali al-Omair, the Saudi Minister of Oil, stated that “currently I don’t believe there are any chances that the OPEC members reduce their output”; furthermore he said the markets should consider the fall of oil price down to USD 76-77 per barrel.

DISCOUNT PRICES

Such a statement is to be considered seriously as it is backed by deeds showing the output cuts, in view of price increases, are not the first option for the OPEC countries; on the contrary, according to the traders, the Saudi company Aramco (the biggest oil producer in the world) offered significant discounts from October 1 to the buyers from Asia; through this offer, the Saudi oil price reached the lowest level since 2008. The Saudi decision – which brings further pressures towards lower oil prices – is surprising not only as against former reactions during similar conditions, but also because it seems contrary to its own interest – the one of selling oil at higher prices.

dynamics-of-brent-and-wti-oil-pricesConcomitantly, Kuwait – Saudi Arabia’s main competitor in terms of market share – did not remain in stand-by; also starting by October, Kuwait has reduced the oil prices for exports to Asian countries by offering the highest discount against the Saudi oil price (50 cents per barrel), during the latest ten years (it is worth mentioning that Iraq and Kuwait are deciding on their oil exporting prices depending on the Saudi oil price). The Saudi and Kuwaiti decisions were followed soon by Iraq (placed fifth at world level according to reserves and eighth according to output) which, in its turn, reduced the oil price by offering (also to Asian clients!) ‘Basra Crude Oil’ with the highest discount against the same Saudi oil reference price, in the latest twelve months. Such moves reveal we are witnessing a battle within OPEC for market shares, a discreet one in the public space. It is a battle carried out on the output and prices frontline by all states, with all weapons and by assuming all risks involving the decrease of budgetary revenues. As most exporting countries’ budgets are dependent on oil sales – on bigger or smaller scale – we can state out we are witnessing a real war of prices.

OPEC’S TWO TARGETS

Within the context of falling demand and falling fuel consumption in Europe, the traditional producers are redirecting interest towards attracting and securing the contracts with the Asian partners, the best strategy OPEC could have adopted. After all, Asia is the only economic area that offers the perspective for sustainable energy demand, from the economic and demographic points of view.

The oil producers’ orientation towards this region is entirely understandable; the discounts offered for the Asian clients – consequently laying pressure on oil price at world level – are making sense; the more so that the price can be used as a double-edged knife: not only for securing a market share in Asia, but also as an attack against the ones to be ‘blamed’ for undermining the status-quo (dominated by OPEC!). Meaning – the American producers of shale oil.

oil-price-at-the-four-years-lowest-levelThe US and its oil producers are mentioned clearly in the statements of Saudi officials, at stake being to keep the oil prices low for a period of time long enough to make the American shale oil exploitations unprofitable and force them out of the market.

US-OPEC CONFLICT

At first glance one could talk about a tough war on the global market of oil and even about tensions between Saudi Arabia and the US – the latter’s massive offer on the market becoming a menace for the Saudis. The combative attitude of Saudi Arabia towards the US could be seen as a signal that the Saudis are not going to give up in their attempt to regain influence on the market on long term.

A Saudi ‘attack’ against their main military and political partner could aim to drive away from the market the American oil producers; however, this dispute is not meant to go over the boundaries of a single commercial dispute; a dispute within set limits (more or less formal and official) by the Riyadh’s political and military dependence on Washington. Meaning that the ‘war’ declared by Saudi Arabia against the US shale oil producers is not going to influence the US economy more than the Americans themselves are ready to accept! - despite the fact that the studies reveal that, if the oil prices go down to USD 75 per barrel, an important part of the American oil producers using the hydraulic fracturing technologies (the engine of the US oil and gas boom) are to become unprofitable and would be driven away from the market. Concluding, the recent position reached by the US on the global oil market is almost unshakeable; this means the world should better get used to the new levels of prices (low!) as the US are to remain a dominant player on the international market in the field.

THE US DOMINANCE

We should add that, under the circumstances, the US have two major competitive advantages: the first one is that the American currency will remain, for a long time probably, the only one (or the dominant one) used for oil and gas trading. As the ‘printing press’ for USD is subordinated to the Federal Reserve, the US are able to use this tool according to their wish. The second competitive advantage is deriving from the fact that, as the know-how and the technology are now available, the shale oil and gas reserves could be closed down for a period of time, but they could be reopened for exploitation at any time. This means the US will have a ‘best card’ easy to use at anytime, being thus able to control the direction the markets are heading to. Even more, the US economy is structured in such a way that it has an immense capacity to self-regenerate by accepting and assimilating losses, which leads to the re-launching of some collapsed sectors; last but not least, one should not overlook the extraordinary capacity of the American economic environment to invent and innovate – which might lead to new wave of technological advance, and thus to the significant decreases of efficiency levels of the current exploitations.

RISKS FOR OPEC

As a consequence, if the game played by Saudi Arabia and other OPEC members would really aim at placing the US oil and gas industry in difficulty and bring back up the international oil prices, this might not be an easy step. There is also the risk of negative effects for these countries, such as the ones generated by the decrease in budgetary revenues, which could be hard to handle. Most of the Middle East countries might use their currency reserves (in several cases at high levels) to face the challenges. Or they could use the ‘weapon’ of increased sales (and thus the market share!) – as Saudi Arabia, Kuwait, Iraq and, unofficially, Iran, are already doing. Nevertheless the margin is limited in time; even if the efficiency margin of the exploitations in the region might look as being enough to support a ‘war of prices’ on long term, there are lots of countries for which the domestic situation (as Venezuela or Iran, facing economic crisis) makes it impossible to bear low prices on long term. Another serious limitation is given by the fierce competition between the main players (the cases of Saudi Arabia, Kuwait and Iraq, which have started the assault by offering substantial discounts on the Asian market).

THE LOSERS...

The new global economic context thus reveals that the consequences of this ‘competition’ between the OPEC members on one side, and between OPEC and the US on the other side, are complex and extensive from the geographic point of view; they stand huge chances to lead to unexpected geopolitical offers. One of the most delicate situations is faced by Russia, caught into the open and heated dispute with the West!

the-rouble-on-demand-trendAs the Brent oil price has fallen from USD 115 per barrel (in June) to USD 86 per barrel (by mid October), Russia is facing a huge problem determined by the fact that two thirds of its exports are made up of natural gas and oil. Anticipations are upsetting for Moscow! According to a study carried out by the American investment bank Morgan Stanley, each 10 dollars decrease of oil price leads to a fall in Russia’s revenues from oil and gas exports by USD 32.4 billion, i.e. approx. 1.6 percent of its GDP, leading to a fall in budgetary revenues of some USD 19 billion. Following simple logic, the fall of oil prices has already ‘cut down’ some 4.8 percentage points of the potential GDP growth for Russia this year, and has blown away some USD 60 billion representing budgetary revenues. According to such estimations (Morgan Stanley considers the probability match is of some 45 percent) the budgetary deficit will go up by 2 percent in 2015, while the inflation rate will go up to 9 percent. Cutting a long story short, Russia’s economy might fall next year by 2 percent, entering recession.

From the publicly expressed Russian officials’ point of view, things are rather different: the economy will evolve positively, although the growth rate is expected to be modest. This positive view is broken up by the Morgan Stanley specialists. They say that in a stalling economy with an economic environment marked by uncertainties, investments and demand will fall, while the salaries in the public sector will be under great pressure to be cut; concomitantly, inflation is expected to remain high due to importing restrictions, the Rouble will be under pressure due to massive exits of capital, while currency reserves might be consumed in order to support the Rouble’s exchange rate.

Unfortunately for the Russian officials, the evolutions on the currency markets seem to support the Morgan Stanley perspective: October witnessed new lows in the latest five years for the Russian currency against the EUR and the USD; by mid October the EUR was above the 50 Roubles threshold, while the USD was above the 40 Roubles one (see the chart “The Rouble, on downward trend”).

By mid October, Moody’s has cut the sovereign rating for Russia to Baa2, only five months from the moment when S&P had also reduced the rating for Russia’s debts to BBB- (the final level before investment grade) with negative perspective. A new downgrading coming from the rating agencies could place Russia in the ‘junk’ level, a position leading to increased financing costs for the public debt, while the national budget gets under the pressure coming from falling prices for raw materials.

As a consequence, in such a negative scenario, Russia might meet serious threats against its economy and its political interests, supported until now by its big companies in the field of oil and gas. Such companies will lack governmental financial support after being hit by the EU and US ban on accessing money from the western financial markets. Under these pressures, Russia could be forced to revise its attitude on Ukraine so that it regains access on the western markets and to western capitals.

... AND WINNERS

On the other side of the barricade there are winners among the developed countries – the big crude oil importers! For the economies of Japan, China, India or the EU, the plummeting oil prices mean smaller financial effort in order to pay for energy imports, but also support for the re-launching of the economic activities. A low price of oil means cuts in production costs and transport costs and more money available for the population’s consumption (as well as for the companies!). Such an evolution is not risk free; at least not for the EU economies, on the brink of deflation, where energy prices increase has been one of the few elements that supported the consumer price index at an acceptable level for the European Central Bank (ECB). The fall of the oil price could give a negative hint on the European economy, pushing it to a generalized price decrease (deflation) – a process some economists say it is more dangerous for the economy than the one involving price increases (inflation!). It is a dangerous process because in Europe the deflationist risks are doubled by the risks of a most probable amplification of the tensions between Germany and ECB, fuelled by the different approaches regarding the management of the inflationary/deflationary process.

October proved to be a turbulent interval for global economy, the turbulences being noticeable first of all through the stock exchanges indexes – considered an indicator anticipating the evolution of the real economy – as they have fallen to the level of prices registered by the end of 2013 (losing the entire gains this year). For the economy’s foundations, much more important are the turbulences on the oil market as they change balance of power at global level and are questioning political and economic stability in many areas of the world.

There are lots of voices saying that, by its amplitude, implications and mainly by the persistence of effects and lack of solutions, the crisis that began in 2008 could not be fully overcome unless a conflict takes place. Through the nature and the profoundness of the implications, but also through the way the political and economic system is altered at global level, we might say the world is already going through such a process. We are practically witnessing a real conflict... even if it is one related to oil, meaning that the steep fall of oil price registered lately could be a relevant signal that the global economy is getting ready for re-launching, after all.

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November 2014

June 2017