One truth eternally rears its head in global oil markets: When the current price for oil no longer clears the market, it will drop. The inverse is also true: When supply doesn’t meet demand, the price will rise. Likewise, the market’s perception of each condition, rather actual data can also influence prices.
That means we can take instruction from understanding past events that have impacted oil and apply them, with a timing caveat, to present day. Timing is critical because no one can really say exactly when the market will respond, one way or the other, to the larger forces influencing it. When you shoot a rocket at the moon, you don’t aim for where it is now, you calculate the trajectory and aim where you think it will be. Calculating what will happen with oil and gas prices is a lot like that conceptually, although there are many more moving parts to the analysis that makes the ‘timing’ issue relevant.
Recently the endgame for the OPEC meeting has become clearer. A brief discussion follows.
Russia and KSA
This picture of a budding ‘bromance’ between Russian President, Vladimir Putin, and Saudi Crown Prince Mohammed bin Salman should dispel any doubt about the Russian dictator’s intentions vis a vis the Middle East.
Source Putin warmly ‘high fives’ the Saudi Crown Prince in Buenos Aires.
You may have read in a recent article where I opined about what their likely response might be when confronted with the decision to retain their previous captive market in Europe with low prices, or whisper sweet-nothings in the ear of the Saudis. Here is a key quote from that article, if somehow you missed it.
“Russia is harder to forecast because of the political element’s influence, but on the balance, I think political goals will win the day. Putin would like to blunt U.S. influence in the MEA region and may use the price of oil to achieve this goal, even at the cost of some of their European sales. The Russians also have competing goals, maintaining their traditional European markets and buddying up to the Saudis. Trying to strike this balance will probably result in support for the oil price.”
Events have over-taken and ratified the latter view- of filling a vacuum in current U.S.-Saudi relations, as evidenced by the display between the two men in Argentina. The current gnashing of American political teeth over MbS’ little indiscretion in Turkey, creates an ideal opportunity for the old Russian spook. Ripping a page from what I would be willing to bet is lesson #1 in the KGB operations manual, “Never waste a crisis”, Putin is just making sure that MbS knows that if the Americans continue to snub him, he has a friend in Russia. There is no downside in this transaction for Putin, as there is in America. After all enemies of Putin has been known to occasionally…be taken off the board, so-to-speak. These guys have more in common than meets the eye. Related: Oil Output Cuts May Be Coming But Don’t Bet on It
That said, as far as I am concerned there is no mystery left in the OPEC meeting next week. Not that they will skip it. Far from it, what sane person would miss a party in this legendary city? The party will go on as planned and an announcement of production cuts will be forthcoming. Saudi Arabia and Russia forming a swing bloc, once again.
A trip back to 2015-16
The world was awash in oil thanks to KSA’s 2014 decision to flip 180 degrees on their multi-year tradition of defending oil prices and go instead for market share. Over the next year and half, they filled up every canoe, and tea kettle on the planet…and the price plummeted…and plummeted. With WTI bottoming in Feb of 2016 at $26 and change.
The Saudis were now getting so little revenue from their primary source of income that Imperial economic initiatives were being threatened. So, in late 2016, they called a meeting that resulted in the withdrawal of about a million barrels a day from the market. And, something also happened that hadn’t happened since 2001. The Russians joined in.
It took a little time after that, but by the middle of 2017 oil began a price ramp that continued largely unabated until October of this year. The reasons for the sharp decline have been discussed here and elsewhere. Waivers to the Iran oil sanctions (short-term though they are intended to be) have stripped the sanctions of any teeth, causing oil to enter its current sharp decline.
So, wrapping this section up. The warmth of the greeting between MbS and his best buddy in the entire world is more than symbolic. After buying off on the U.S. insistence that they must ramp up production in the face of the coming severe sanctions on Iran, only to have the rug and the oil price pulled out from beneath them…the Saudis can be forgiven for looking for a new set of friends.
One of the things that worries me about the nationalistic point of view so often expressed by our current president, is that we don’t live in a vacuum. We need friends in the world (however grim they may be in reality), who feel they can rely upon us to consider their interests as well.
It is pretty well known that the Saudis need the price for Brent in the middle $80’s to balance their books. We’re a long way from there currently. This is a fact that gets no recognition seemingly from the Administration. We live in a connected world. This little trick we played on the Saudis will come back to haunt us in ways we can’t really predict at this point. Related: Will Canadian Oil Producers Cut Output?
For the record, I think much of American trade policy as directed toward China, is right on target. I hope we stay the course we’ve set upon with them. Russia is a bad actor and has committed numerous misdeeds in recent years. Whether they will ever be truly called to account for Crimea remains to be seen. But, in terms of impact on the U.S. they pale in comparison to the economic and military threats posed by China.
Summing up this section: It is safe to say that the fabric of the trust that has existed between the U.S. and Saudi has been pretty well trampled by the waivers on Iran. I know how I’d feel in their position. If I was MbS, I might just be ‘high-fiving’ Vladimir Putin on the world stage to show my American ‘friends’ that perhaps it’s “Time to see other people.”
On the world stage as in personal interactions, that is never a good point in a relationship.
Where do we go from here?
I don’t seriously expect the U.S.-Saudi relationship is going to be irreparably damaged. We have too much in common in terms of the stability of the Middle-East region for that to happen. I think cooler voices will prevail in terms of sanctioning KSA over the murder of Khashoggi. But the relationship will likely be different, perhaps a little more tense. We have opened the door to the Great Russian bear, and we’re going to have to deal with the consequences of our actions.
Over the short run, assuming that I am correct, and we get a significant production cut next week, we will have to wait for the world to sop up some of the excess oil in floating storage. We have had 10 weeks of steady crude builds that will have to be worked off. Nor, do we yet know how quickly the cuts will be implemented.
We will also have to see how long it takes for the shale frackers modify their behavior in the face of $50 oil. We haven’t seen any signs so far, with a few rigs continued to be added each week. At some point the frackers will wake up and determine that oil at $50 doesn’t go as far as oil at $75 and tap the brakes just a hair. We are also due for a seasonal pause in some of the U.S. Northern areas, as winter takes a bite out of drilling activity.
In practical terms we will probably be well into the first quarter before we see any impact from OPEC production cuts. However, once we do, it will be like June of 2017 all over again, and the price of oil could strongly respond to the upside.
By David Messler for Oilprice.com
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