Before Natural Gas, in the nineteen sixties and seventies, UK industry burnt oil, heavy stuff full of sulphur that created a yellowish haze over industrial regions. Electricity and Gas were purchased on tariff from the regional boards and apart from checking the tariff, all negotiation activity was centred on oil. There was nothing very aggressive about the process as buyers were more concerned about securing supplies than getting a good deal!
Yet, today, the only real direct application that it affects is in terms of fuel for deliveries. For brewers, the price of fuel is built in to their manufacturing costs while for the plastics & rubber industries, the price of oil impacts on their raw material costs and then we come to transportation and distribution where there is little else, other than oil. It is still a major influence on our economy.
In the media, there is massive interest in the oil market – as across the world its price is critical and creates much of the current geo-political tension. Although many OECD countries have weaned themselves off oil, the developing world, primarily India, China and the rest of Asia and South America are very dependent on it and those countries make most of the goods that the rest of the world seems to buy. Across Europe the price of gas in linked to the price of oil and even with the time lag, the two track each other closely, also because they are interchangeable. So when OPEC meets or makes a statement, there is an immediate reaction in the media
Last year, OPEC, led by Saudi Arabia announced that with supply exceeding demand, OPEC would not cut unless other producers did. Increased US Shale production had created the surplus and OPEC saw no reason to cut to let US shale increase its market share further. Then, earlier this year, following the misreading of a journalist’s tweet, the market assumed OPEC would meet with non-OPEC producers and cut. Some OPEC members jumped on this and the meeting agenda developed to the point that both Russia and Saudi were present.
A deal was reached at which both agreed not to exceed levels set in January, which were at maximum anyway. Much excitement, but it didn’t mean anything! Then we moved on to the Doha meeting in April, which ended without any agreement at all being reached, supposedly because Iran would not attend and agree to cap its output at pre-sanctions level. In the background to all of this, with sanctions lifted, Iran now has the opportunity to put another 1.2mbpd into the market and will not agree to cap its output until its full quota has been realised which impacts seriously on Saudi. Iran needs to move its shipments through Saudi waters and Saudi is doing its utmost to restrict this!
Saudi knows that if OPEC announces a cut, Saudi will cut and other OPEC members will increase as will the non-OPEC producers, leaving Saudi with a reduced market share. For this reason, Saudi initiated the policy of maintaining output at any cost, to starve out the other producers, including some OPEC members. Furthermore, there is no reason for Saudi to work with either Iran or Russia who are not only its direct competitors but who also maintain differing stances over Yemen and Syria, for example where they are on opposite sides.
The turmoil continues with many OPEC members, including Saudi, suffering financial loss with the price of oil below the $100 level, but, it is picking up, fuelled by conjecture that supply and demand will come back in to balance.
US shale production output is falling and by early next year could have lost almost 1mbpd which is the surplus figure so readily banded around. Against the threat that “oil could fall to $20” put out by a certain bank earlier in the year, the market has kept itself in short supply. However, following the excitement of the earlier meetings this year and with the next OPEC Meeting only three weeks away on 2nd June, there is the view that “something” could happen. The market is gearing up prematurely and the price is moving up with it.
The developing world is picking up, supported by lower oil prices and car sales in Asia are moving up too, while Americans are getting out and about more now, thanks to lower gasoline prices. Yet, we must not forget that although the US shale production has been curtailed it will start to plan its return, once the oil price moves over that $50 level and heads towards $60 and that will be the serious reality check for OPEC.
Saudi policy for many years has been fronted by Ali Naimi the veteran oil minister, well known in OPEC and across the world in energy circles. He has just been “replaced” by Khalid al-Falih, and this signals change in the Saudi camp. The policy of maintaining output at any cost has come down directly from the top and it will be interesting to see what this change will bring to the next OPEC Meeting. My guess is that the Saudi policy is starting to work well for Saudi, in spite of the financial shortfall, and having come this far, the pressure on the market will be maintained beyond this next Meeting. However, in spite of following “fundamentals” and “technical” OPEC provides the third dimension which does not necessarily follow any other.
Written By – John Hall