The world oil market: Troubled times ahead, increasing uncertainties

For the oil industry 2016 has begun worse than 2015 has ended. Brent oil prices fell in January under USD 27/barrel, and later on have returned timidly to around USD 30/barrel due to the higher demand coming from the very low temperatures in the northern hemisphere, on all continents. Thus, we see that the oil price drop is over 70 percent against the summer of 2014. The context is an agitated one.

The lifting of international sanctions against Iran on January 16 (imposed in July 2010) allows it to return to global markets with significant exports, counting on increasing the oil exports from 1.1 million barrels per day to 1.6 million (in a first phase) and, within a year, to 2.1 million barrels per day. On a world market facing oversupply of about 2 percent, the newcomer will add, according to experts, a surplus of 0.5 percent.

On the other hand, the year has begun under the sign of tensions between Iran and Saudi Arabia, increased right after entering 2016, following the execution by Saudi Arabia of 47 people, including a prominent Shiite cleric. Tehran showed immediate outrage, city streets got filled with protesters who attacked the Saudi embassy. Riyadh decided to cut off the diplomatic relations with Tehran and other Gulf States have decried Iran’s failure to protect the embassy. A few days later, Iran accused Saudi Arabia of deliberately striking its embassy in Yemen.

Finally, to all this turmoil it adds the crisis at the Shanghai stock exchange and China’s economic growth slowdown. The economic growth slowdown comes along with the dramatic fall in oil prices and with the devaluation of several international currencies. In China, the capital outflows in the first 11 months of last year totalled USD 843 billion. On the other hand, Beijing’s foreign exchange reserves fell from USD 4 trillion in 2014 to USD 3.3 trillion. In mid-January the stock exchange in Shanghai witnessed the CSI 300 index fall by 5 percent in only 13 minutes. The stock exchange was closed down for a quarter of an hour, with the hope traders will calm down. What followed was an avalanche of offers for sale which put further pressure on the index, so the stock exchange was closed down for the whole day - the second time in the same week. A fresh fall was to come only days later.

Iran - Saudi Arabia, rivalry including in the oil sector

Saudi Arabia is to blame for the oil price developments and, even further, it hurts its own economy because it is a ‘supporting producer’, meaning it produces so much oil that it can change prices depending on how much crude is sent on the market, said Dr. Nariman Behravesh at the Economic Forum in Davos. The Saudi budget deficit in 2015 reached no less than USD 98 billion, on the background of the falling value of oil exports. As Riyadh seems available for a long-term ‘game’ with the oil price - based on its large foreign exchange reserves - oil is likely to drop to USD 20/barrel; winners are the consumers in the developed world, losers are the oil producers with high costs such as Venezuela and Russia, he added.

A sign of the downturn of Saudi Arabia’s economy is the announcement early this year that the authorities consider the sale of a share of the state oil company Aramco, regarded as the most valuable company in the world, owning proven reserves of crude oil of about 265 billion barrels (more than 15 percent of the world reserves) and an output of 10 million barrels per day. “It is an issue being reviewed,” said Mohammed bin Salman, a son of King Salman, asked whether it is possible to sell Saudi Aramco shares. “I believe it is in the interest of the Saudi market, and it is in the interest of Aramco,” he said, adding that a decision would be taken in the coming months. Nothing is certain, but analysts evaluate the company about a trillion dollars, even if one of the ‘secret’ companies in the world, as it doesn’t provide information about the revenues and provides only bits of information about the hydrocarbon reserves. Various sources say approximately 5% of the shares will be out on the market.

Khalid al Falih

In this context, the President of Saudi Aramco, Khalid Al-Falih (photo) , said in Davos that current oil prices are ‘irrational’, the minimum level should be around USD 30/barrel. “The market has overshot on the low side and it is inevitable that it will start turning up,” said Khalid Al-Falih at Davos.
Iran, in turn, sees a chance in the lifting of international sanctions and its return on the international oil markets. On one hand, both Iran and the Iranian companies can repossess the assets blocked abroad of USD 50-100 billion and regain access to the international banking system. As we were saying, in a first phase Iran aims to increase oil exports by 500,000 barrels per day, and in a year’s time the increase would reach one million barrels per day. According to the World Bank assessments, the flooding of the international oil market by Iran could lead to a further fall in the price per barrel by about USD 10.
In addition, after years of semi-stagnation, relying on oil, Tehran aims in 2016 an economic growth of 8%!

Specifically, oil deliveries to the European Union will begin in February. State-run company National Iranian Oil is getting ready to supply a quantity of one million barrels of crude oil to the Mediterranean port of an EU country, Tehran’s main target market being Europe, followed by Asia. Interestingly, anticipating the intent, Saudi Arabia and Russia have offered, in the previous months before the lifting of sanctions, aggressive price cuts in Europe to have a substantial market share before Iranian oil’s arrival.

Iranian officials have kept the destinations secret, various sources stating that they would be refineries in Spain, Italy, France and Greece (Iran’s former clients before sanctions). Some sources claim that Iran has already signed a contract to supply oil to a refinery in Greece - Hellenic Petroleum SA (before sanctions Greece was one of the biggest European importers of Iranian oil). The same officials did not hesitate to announce that more Western companies have ongoing negotiations to purchase Iranian oil: Total SA, Royal Dutch Shell PLC and Cepsa. The optimism comes from the fact that European refiners would prefer to reduce inflows of Russian oil because their facilities are better equipped to process Iranian oil.

The rivalry between Saudi Arabia and Iran is shown in the oil sector, as revealed. The rivalry on the field is even tougher. Several analysts have openly expressed fears of possible open conflict between the two countries, although the Persian Gulf stands between them. And yet... it’s just a war of statements. Saudi Prince Mohammed bin Salman supports his country’s decision of January 3 to cut off diplomatic relations with Iran but denies any likelihood of direct conflict. “A war between Saudi Arabia and Iran is the beginning of a major catastrophe in the region. For sure, we will not allow any such thing,” the prince said.

The other party does not speak of war either. Asked about such a possibility, Iranian foreign minister Javad Zarif said: “No. I think our Saudi neighbours need to realize that confrontation is in the interest of nobody. There is no threat coming from Iran to any of its neighbours.” The Minister added that extremism and terrorist groups such as the Islamic State are a common enemy to be defeated.

China - major interests in the region

Not coincidentally, at the beginning of the year - starting on January 19 - Chinese President Xi Jinping has toured the Middle East with visits to Saudi Arabia and Iran, with an intermediate stop in Egypt. The tensions between the two countries disquieted Beijing and other big chancelleries of the world as well. China is the more concerned as it is the biggest importer of oil from the two countries, and would not want to witness a disruption of the oil flow. The imports of Saudi oil to China have increased by 2% last year.

On the other hand, the Saudis are trying for a long time to build closer ties with China and to build refineries in partnership. Aramco is negotiating for years with China National Petroleum Corp. (CNPC) to build a refinery with a capacity of 260,000 barrels per day in Yunan province and to buy some of the shares of a refinery owned by the Chinese state company.
During the Chinese president’s visit to Saudi Arabia, 14 important agreements were signed, including a memorandum of understanding on the construction of a high temperature reactor (HTR).
In Iran, China’s interests are directly proportional to the involvement in economic terms. China is the largest trading partner of Tehran and the largest importer of Iranian oil - during eleven months of 2015 it imported 24.36 million tons of crude oil from Iran, equivalent to 8% of world imports. Chinese oil companies have increased their investments abroad. One of the projects includes North Azadegan Oilfield Project near the Iran-Iraq border, where 480 CNPC employees work and that has a production of 75,000 barrels/day.

In Tehran too, important documents were signed, no less than 17 Chinese-Iranian bilateral papers, particularly in the nuclear field, in parallel with the bilateral decision to establish long-term strategic relationships.

Lots of unknowns

The Chinese President’s visit took place in difficult times for both his country and for the hosts. The slowdown of the Chinese economy’s growth raises question marks regarding its demand for oil, a decrease would affect Saudi Arabia and Iran, but that would also influence the global oil prices. Many comments during the visit concerned a ‘battle’ between Iran and Saudi Arabia to secure their exports to China, but as it can be seen, Beijing wants balanced relations with the two largest oil producers in the Middle East.

There are major concerns about China’s development, following the economic growth data in 2015, which point to the lowest growth rate in the last 25 years, of 6.9%. January was a troubled period for the Chinese stock exchanges. Opinions are divided in regard to what lies ahead, some see a simple slowdown of the economy, others say we witness symptoms the Chinese economy is approaching a ‘hard landing’.

The economist Joseph Stiglitz, Nobel laureate, said in a recent interview that, in his view, China is not facing a cataclysmic economic slowdown and that the turbulence in January on the international financial markets was rather the result of a capital markets short-circuit. What happens in China is a slowdown at all levels. But it is a moderate slowdown, not a cataclysmic slowdown, Stiglitz emphasized. What we see is a lack of global demand. China has plunged into the global economy. There are internal matters that affect it and exacerbate the situation, and if it doesn’t adopt sufficient measures regarding demand, there might be a deeper recession, Joseph Stiglitz underlined.

On the other side of the barricade stands billionaire George Soros, who said at the Davos Economic Forum, referring to China’s economy, that “hard landing is virtually unavoidable. I don’t expect it, I am watching it.”

George Soros is one of those who have repeatedly warned in recent years about the danger of repeating the 2008 crisis, starting from concerns about China, which have shaken the global markets and in particular have led to investors’ loss of confidence, he himself being one of them.
Talking about China’s influence on the world oil market and the world economy, it must be said that the current level of crude oil imports is motivated by the fact that Beijing is taking advantage of the low prices on the market in order to build up its strategic reserve - a project unfolding until 2020 which aims to cover 100 days of national consumption. The high level of imports has attracted some of the surplus on the oil market, stopping to some extent the decline in oil prices at a faster pace. But, as some analysts say, the demand for the building-up of the strategic reserve will not last forever and then the world market will be more ‘flooded’ by the offer.
On the other hand, China’s economic slowdown has reduced the growth rate of demand for oil - in 2014 it increased by only 3% (300,000 barrels/day), under half the pace registered in previous years.

Therefore there are a lot of unknowns on short and medium-term. As OPEC does not intend to reduce production in view of increasing international oil prices, and other major exporters, such as Russia, are forced to export as much to support their domestic budget, it is difficult to anticipate a change in trend. Should we expect China to attempt to take an initiative of global coordination among producers and importers of oil, at the G20 summit which it will host in early September in Hangzhou? In principle, China aims to reinforce its global role and transform the summit from a crisis management forum into a long term global coordination platform.
For now, uncertainty leaves no room for expectations in the next few months. But it is perfectly possible that significant developments on the world oil market to be decisively influenced this year by the decisions of the two rivals in the Middle East and by the developments of the Chinese economy.

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