Why Oil Prices Aren’t Dropping More After Failed Doha Talks

 

Whilst much was initially made of the collapse of OPEC talks with Russia over the weekend at Doha, it makes little difference to the balance of supply and demand in the global oil markets. The putative freeze in crude output was political eyewash.

Hardly any country in the OPEC cartel is capable of producing more oil. Several are failed states, or sliding into political crises.

Saudi Arabia’s hard-nosed decision to break ranks with its Gulf allies at the meeting in Doha – and with every other OPEC country  – punctures any remaining illusion that there is still a regulating structure in global oil industry. It told us that the cartel no longer exists in any meaningful sense. Beyond that it was irrelevant.

Market dynamics are changing fast. Output is slipping all over the place: in China, Latin America, Kazakhstan, Algeria, the North Sea. The US shale industry has rolled over, though it has taken far longer than the Saudis expected when they first flooded the market in November 2014. The US Energy Department expects total US output to drop to 8.6m barrels per day (b/d) this year from 9.4m last year.

China is filling up the new sites of its strategic petroleum reserves at a record pace. Its oil imports have jumped to 8m b/d this year from 6.7m in 2015, soaking up a large part of the global glut.  Some is rotating back out again as diesel: most is being consumed in China.

Goldman Sachs says the twin effect of rising demand and supply disruptions across the world is bringing the market back into balance, leading  to a “sustainable deficit” as soon as the third quarter.

Oil prices steadied yesterday after a Kuwaiti workers’ strike, the first of its kind in 20 years, slashed more than 60% Kuwait’s crude output, lending support to price benchmarks such as Brent and Dubai.

Kuwait’s woes are the first taste of how difficult it will be for the petro-sheikhdoms to impose austerity measures or threaten the cradle-to-grave social contracts that keep a lid on dissent across the Gulf.

There is little doubt that Mohammad bin Salman, the deputy-crown prince and de facto ruler of Saudi Arabia, wanted an excuse to sabotage the Doha deal. He added a fresh demand that non-OPEC Norway should also limit output – a non-starter –  as well as hardening the Saudi objection to Iran’s full return to pre-sanctions output.

The calculus is that his country has the deepest pockets and will ultimately stand to gain by shaking out weaker players.  This is a gamble. Saudi Arabia is running through $10bn of foreign exchange reserves a month to plug its fiscal deficit. The fixed riyal peg makes it much harder to roll with the budgetary punches as Russia is able to do with the floating rouble.

However, Saudi Arabia is not as rich as often supposed. Per capita income is the same as in Greece.  Standard & Poor’s has cut its credit rating twice to A-, and for good reason. The Saudis never built up a proper sovereign wealth fund in good times. Their reserve coverage is two-thirds less than in Kuwait, or Abu Dhabi.

The Saudi price war has several targets. A top official hinted at the hierarchy a month ago, listing Iran, Russia, the Arctic, Canada’s oil sands, Venezuela’s Orinoco tar, ultra-deep water wells, US shale, and renewables, in that order.

The primary foe is obviously Iran, the leader of Shia Islam and arch-rival for strategic dominance of the Middle East.  The two countries are at daggers drawn in Syria, Yemen, and Iraq.

Many suspect that the secondary undeclared foe is Russia, currently the world’s top producer at 10.8m b/d but short of money and running down its infrastructure. The Kremlin will exhaust its budget reserve funds by the end of the year, forcing Vladimir Putin to contemplate draconian budget cuts. The Saudis may think it worth going for the kill by trying to hold down prices for a few more months.

The trouble for the Saudis is that their strategy has probably killed OPEC – the instrument that leverages their global power – and may set fire to their own strategic neighbourhood, if it has not done so already.

Helima Croft from RBC Capital Markets has raised the bank’s stress gauge for “geopolitical risk” on six OPEC countries, warning that several are on a precipice. “Many were struggling with political and security challenges when oil was above $100 and they are now being forced to seek emergency lending,” she said.

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Venezuela has already collapsed.  It is on a four-day working week. Inflation is 700%. Nicolas Maduro’s regime is running out of money to pay oil workers. It risks a repeat of the strikes in 2002/03 that cut oil production by 80%.  Without Chinese funding it faces a “humanitarian catastrophe” this year, she said.

Nigeria has lost 390,000 b/d in output due to a wave of assaults by militants since the Buhari regime ran out of protection money  to pay them off. These included a sophisticated underwater attack on a Shell pipeline at the Forcados terminal.

Iraq is supposed to be the great hope of global oil supply over next decade but is in no better shape. The collapse in revenues has set off a vicious circle, with delayed payments to contractors leading to an investment strike. It too is in the arms of the IMF.

ISIS terrorists set fire to oil wells in the Khabbaz field near Kirkuk last week.  Suicide bombers struck in Basra early this month, and terrorist actions are moving ominously close to the Iraqi crown jewel, the Rumaila oil installations. Security officials say ISIS is targeting the oil heartland, yet the government is so desperate for funds that it cannot pay vitally-need Shia militia groups.

Any one of these countries could spin out of control. It is not far-fetched to imagine two or three occurring at the same time. This would change the dynamics of the oil markets in a heartbeat and would bring the ageing post-Lehman expansion of the global economy to an abrupt halt, exposing the nasty pathologies that have been building up.

It never was cheap oil that threatened our economies. The scare earlier this year was misguided. It is the next oil supply crunch we should fear most.

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