So this is what winning looks like.
Jackie Forrest: Why the OPEC price war will rage on
November 27th marks the one year anniversary since Saudi Arabia made the watershed decision to pivot from protecting oil price to maximizing market share. The members of the cartel will meet again, to ponder if they should stay the course on the decision made last year, or intervene in what is proving to be the greatest oil market downturn in decades.
A year after Saudi Arabia and its OPEC allies began waging a war against U.S. shale and other high-cost producers to grab market share, the group is gathering again in Vienna to assess the damage they have wrought over the global energy industry.
While OPEC’s strategy of maintaining its quota of 30 million barrels per day has driven down prices and left global oil companies retreating from ambitious expansion plans, the group’s own members are also counting heavy losses with massive budget deficits and anemic economic growth.
“What does winning look like, who is this really working for?,” Helima Croft, chief commodities Strategist at RBC Capital Markets, said in an interview from Vienna, where the group began its two days of meetings on Thursday. “The Saudi deficit is 20 per cent of GDP, they have burnt through US$100 billion from their forex reserve, and now they are going to borrow from the international market. This is an amazing definition of victory.”
The drop in oil prices will shift the aggregate current account of Middle East oil exporters to a deficit of US$82 billion in 2015, from a surplus of US$233 billion in 2014. The Gulf states, that include OPEC members Saudi Arabia, UAE, Qatar and Kuwait, will see GDP growth of 3.1 per cent this year, compared to 3.6 per cent for their emerging market peers, according to the Institute of International Finance.
Over the past year, cash-strapped OPEC economies such as Iran and Venezuela have favoured an output cut to support crude oil prices – and their economies. But richer members Saudi Arabia, UAE and Kuwait have repeatedly rejected the idea.
The Saudis also find themselves in a bind: If they agree on a production cut now, it would only strengthen their rivals, and the financial pain they endured over the past year will be for nought.
“It would not make sense for Saudis to back off from that policy and cut production in order to make room for Iran and secondly help U.S. and Russian producers,” says Ann-Louise Hittle, vice-president of macro oil at consultant Wood Mackenzie. “I can’t see why that would be an advantageous move.”
Despite calling for output cuts from the group, Iran is paradoxically poised to raise its own production by as much as one million barrels per day once Western sanctions are lifted next year.
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“I find (Iranian oil minister Bijan) Zangeneh astounding,” Croft said, noting Tehran’s confusing signals of raising its own output while demanding cuts from other members.
“I don’t know how they can compel Saudi Arabia to do anything. That’s the real problem for any consensus to cut.”
Tehran believes OPEC members, which had captured its allotted quota while its production was curtailed by sanctions, must now give way. “The big elephant in the room is Iranian oil production,” Hittle agrees.
On Thursday, Saudi Arabia reportedly floated the idea of a global deal with the help of Iran and Russia, involving a million barrel per day cut, but officials from all three countries have dismissed the suggestion.
“I would not be surprised if the proposal was floated by Saudi Arabia just to test the market and the other OPEC members,” Eugen Weinberg, head of commodities research at Frankfurt-based Commerzbank, told Reuters. “The test was successful to show there is no readiness yet for higher discipline.”
Croft and Hittle won’t rule out a “surprise” cut from OPEC, but it’s hard for Saudi Arabia to justify a pullback at this stage.
Michael Cohen, analyst at Barclays Capital, expects the OPEC meeting to be a “non-event,”as members are unlikely to agree on output cut.
The Saudi deficit is 20 per cent of GDP, they have burnt through US$100 billion from their forex reserve, and now they are going to borrow from the international market. This is an amazing definition of victory
“Though OPEC gets passing grades on the slowdown in non-OPEC supply, the global demand acceleration, and a higher market share, its revenue challenge will mount next year when some previously disrupted supply returns,” Cohen said in a report.
Croft believes the group is more likely to seek cuts when it meets again in June, especially if prices remain around US$40 per barrel, there is more clarity on Iranian production and firmer signs of lower production from the United States.
U.S. crude oil production growth is set to decline next year led by shale producers. And, contrary to popular belief, it is not the new “swing producer” in town replacing OPEC, if prices recover. Other sources of supply, such as the stalled Canadian oilsands projects or deepwater development across the world will also take four to five years to be fired up from their frozen state even if prices recover early next year.
That would leave OPEC with a stranglehold over much of the market, despite its estranged, infighting members.
“A lot of families are dysfunctional but they stay together,” Hittle said. “It’s a very difficult period, and a lot of contention, but ultimately the countries see the value (of sticking together).”