10 September 2022 - 15:55
  • News Code: 461874
Defining Moments for Oil and Gas

TEHRAN (Shana) -- Energy prices went up sharply after February 24 when first Russian troops entered Ukraine. By late March 2022, it hit above $ 120.40 per barrel for Brent briefly but retreated to around $110 per barrel, though, the average price of crude oil was $105 per barrel for the first half of 2022. The slow and cautious reaction of oil market towards such major geographical escalation that would potentially cut over 6.7 mb/d of crude and products from Russia is an interesting phenomenon worth analyzing. Let’s be reminded that the international crude oil prices touched $147 per barrel back in 2008 after the United States descended into recession.

It is also noteworthy that the international oil market has been under excessive pressures and constraints since late 2019 when first indications of COVID-19 pandemic was announced in China. Demand destruction followed and the world lost more than 20 percent of its consumption in less than three months. Such a sudden and massive decline in consumption of energy, notably oil and gas were so phenomenal that market labeled is as demand destruction. However, market has not yet seen a very drastic price escalation in line with the extents of geopolitical and supply disruptions. In fact oil prices began to move upwards after the US and European countries decided to impose sanctions against Russia.

Birth of OPEC+

OPEC+ was born in 2016 but its consolidation as a powerful oil market force was the product of COVID-19 and demand destruction. OPEC and non-OPEC kept a love and hate relationship for over three decades. Sometimes and more frequently they fought over market share. Several delegations shuttled between capitals and OPEC Secretariat in Vienna to negotiate a compromise and hardly arrived at a tangible deal.

By November 2019, world oil demand crossed 100 mb/d for the first time in history and tradable supply matched the demand. Peace prevailed and all seemed satisfied. Once the pandemic began to bite, OPEC and non-OPEC were lost in a market with more than 14.4 mb/d of capacity for which there was simply no demand in the market. Oil producers gathered together and negotiated a collective curb on production that was no more OPEC and non-OPEC but this time OPEC+.

By then OPEC+ meant mostly Saudi Arabia and Russia. These were the two countries that led the newly born group. However, most members of the newly formed coalition weren’t as happy. Saudis who had benefited most during high demand, distributed the cuts in supply to the rest of the group. Nevertheless, by September 2020, market was so desperate that they bowed to the pressure and agreed to the unofficial formation of OPEC+.

As soon as the global oil market concluded that OPEC+ is serious and has come to stay to moderate the market, prices moved up slowly but steadily. Brent moved upward from $40 a barrel and stabilized at $70-80 per barrel range by mid-2021. Most analysts subscribed to the notion that the price was right on both sides of the market and for all players. Most members of OPEC and non-OPEC adjusted their annual oil income budget at around $60 per barrel to be on the safe side. Nevertheless, market was bullish even prior to the tension in Ukraine. Price volatility was the name of the game. Markets did not miss any opportunity to jump upwards. In fact, even prior to the Russia-Ukraine crisis, prices had the tendency to surpass $100 per barrel.
With this short background, I would like to indicate that OPEC+ did a good job in maintaining price stability. However, let’s not forget that prior to the pandemic and since 2015 OPEC and the international oil market were both under severe pressure from Shale oil (and Shale gas). OPEC underwent drastic pressure and production adjustments to maintain space for shale oil and US shale producers forgot to send a thank you note to OPEC for pain it sustained to let shale in.


OPEC and OPEC+

Emergence of OPEC+ in 2016 that includes 87 per cent of the total global traded crude oil production was a milestone. 23 oil producing countries agreed to put discrepancies aside and pull their strength to stabilize the world oil market and prices. At the time of OPEC+ formation, oil producers were in bad shape. They were in dire need of cash to balance their budget deficit. Cooperation and compliance was the key to stabilize the oil market and boost the economy of oil producing countries. Back in 1973 when OPEC entered into its second phase of documented history, the organization of still eight members produced half of the global crude oil supply. The organization went even beyond that and by the middle of 1970’s produced around 63 percent of the tradable crude oil globally.

This came at a cost that was hardly noticed and appreciated. This meant spare capacity. That capacity was built at a cost and maintaining it cost even more. OPEC paid a hefty price to build and maintain the capacity that meant to stabilize the international oil market and often be criticized and even punished for that. While National Oil Companies pumped less oil to support prices, International Oil Companies produced at maximum capacity and benefited from higher oil prices.

OPEC+ and Changing Geopolitical Landscape

According to June 2022 OPEC monthly statistics, the thirteen members of OPEC produced 28.83 mb/d in May, combined with the so called non-OPEC, total production was 42.09. The two major producers Saudi Arabia and Russia accounted for the bulk of group’s crude production.
The official coalition of OPEC+ will be ended by September 2022. The twenty-three-member coalition will end unless otherwise renewed or extended. It’s worth noting that the group was formed to battle the demand destruction even before pandemic. Market was under pressure prior to the pandemic. Members tried hard for higher quota allocation. Mexico decided to leave the coalition after announcing that wasn’t satisfied with allocated quota. The outbreak of COVID-19 as a total disaster for the demand side further consolidated the alliance of OPEC+ amid rivalries for larger market share.

Having said that it seems perplexed if the coalition will survive after the official termination in September. Most producing members aren’t currently producing their full quota. Demand resurgence after the pandemic and wading excess supply capacity began to bite even prior to Russia-Ukraine conflict and the imposition of sanctions on Russian oil.
A sensitive oil geo strategy is at work. Saudi Arabia is a long term ally of the United States. President Biden is said to be visiting Saudi Arabia in July. Biden has a long list of agenda to discuss with the Saudis. I believe that Saudi-Russia relationship is on top of the list when it comes to oil and energy. Biden, like most of other Democrats in the White House, is interested in the Middle East.

Although Trump and Trumpified policies are still in place in Washington, Biden is now visiting the Middle East and Saudi Arabia with a sensitive agenda. America wants to distance Saudi Arabia from Moscow. Biden wants an end to Saudi-Russian cooperation within the context of OPEC+. This coalition is not something that the US feels comfortable about. Biden wants total isolation of Russia specifically when it comes to energy.
On the other hand, Saudi Arabia’s long-policy is in staying in collision with Russia. OPEC was all powerful back in 1970’s to 2000’s. Global oil demand was less than 80 mb/d and OPEC production was around 35 mb/d. OPEC members also consumed much less of their own oil domestically. OPEC is now producing around 28 barrels per day and still consumes more oil at home. Without non-OPEC and specifically Russia, OPEC could have already waned and lost relevance to the world oil market.

Saudis realize that the OPEC+ members are important for the organization to sustain OPEC and the country’s relevance to the world energy market and economy. Saudis’ strategy is considered a smart energy diplomacy.

Russia is a member of UN Security Council. Veto right is the most powerful tool of the Russian foreign policy. For Saudi Arabia and OPEC is strategically important to have Russia in its side. Saudis have many regional and international problems. Issues related to human rights violations, regional conflicts and climate change policies of the Western countries that threatens the future of oil consumption. A Russia alienated with OPEC and Saudi Arabia is a blessing and in the interests of all members of the alliance. OPEC and oil producing countries have been always under pressure by the west. From taking the organization to court for violating the US cartel laws to a cap on Russian oil supply to the international markets. Russia and Saudi Arabia or better said OPEC and Non-OPEC need each other like no other time before in the history of the international oil market.

Under these circumstances, President Biden plans to visit Saudi Arabia to demand an end to the alliance. The timing is chosen close to the formal termination of the OPEC+ agreement. OPEC+ is behind Russia in so far as sanctions is concerned. No oil producing country is immune from US sanctions. Most OPEC members have experienced sanctions one way to the other. For oil producers, sanctions imposed by the Western countries is a warfare tool. Sanctions have long term consequences for the sanctioned country and the global oil market.

Sanctions and Its Future Bearing

America is now the biggest LNG supplier to Europe. The country’s LNG supply to Europe was 18 percent back in 2020. It’s astonishing to note that Europe’s LNG terminals to unload such quality of LNG is limited and US LNG cargoes have queued in Europe’s ports for over two months. This is getting more complicated as the global world oil map is under heavy constraints due to continuous sanction regimes. Not all the oil and gas that is being traded around the world is readily usable in any destinations. Oil and gas from various origins have different DNA. Europe has been using Russian natural gas for some 70 years. Europe cannot use the same oil and gas with no long-term plan and policy. Europe is now taken by a surprise and there’s no remedy in sight.

Winter and cold weather is about four months away. Nevertheless, prior to the arrival of winter in Europe a bigger problem is in store. Hurricane Season will start in the US by September. Normally there are a dozen of hurricanes, five of which is usually devastating. In the Gulf of Mexico where most of the crude, products and LNG is loaded, hurricanes often cause long delays that could be okay for normal circumstances but not for difficult times such as today.

 Europe has limited storage capacity and facilities. Germany as the most industrial country in Europe can sustain some 3 to 4 weeks of storage of gas. Many decades of easy and cheap natural gas from Russia, led unburdened and easy energy supply. Gas was always there for asking. Current disruptions due to the events in Russia Ukraine fronts and consequent US sanctions has left Europeans and most notably Germany with the least energy security defense shield.

On the supply side, options are limited. Qatar, Algeria or smaller producers here and there can offer little relief. Long term supplies of gas from Iran is the most outstanding options. Iranian energy diplomacy is at work quite actually but sanctions have closed the avenues. As such supply alternatives is limited.

One important factor that has come to play is Russia’s demand to ask for Ruble for its supply of oil and gas to a number of countries. This is a determining factor in the international energy market. Saudi Arabia and the United States of America agreed to price oil in US dollars. In fact, oil has almost been priced in dollars after the Second World War. Oil alone constituted some 18 percent of the world transactions for years. The dollar owed its eminence to oil money.

OPEC members including Iran tried to decouple oil from dollar in different times unsuccessful. However, currently Russia has officially asked certain countries to settle their payments for energy in Ruble. Russia’s foreign reserves are sanctioned and for Russia to earn its income from energy sales, the option is asking for payment in rubles. This is a game-changer. If Russia can price its energy in its own currency, other countries may follow. In fact, a couple of countries subscribe to the notion that to tie up oil and dollar would render the United States a remarkably high position to exert power on other countries. This has been spelled out by China and replacement of the yuan in different occasions. The only major obstacle; however, remains is the substitute for the dollar. How to avoid a major disruption that might be caused due to years and decades of dollar addiction.

As mentioned earlier, asking for Ruble for oil could prove a game-changer. Replacement needs to be worked out cautiously. A basket of currencies with weighted average could be one option.


The Way Ahead

As mentioned earlier international oil market was under tremendous pressure even before Russian-Ukraine conflict and the US sanctions that followed. I am sure that many of us still remember WTI at $37 per barrel. I mean minus $37 per barrel. At the time when WTI was traded at negative price, petrol prices at gas stations were high and in some states in the US people had to wait in queue to fill their car tanks.

By this I intend to bring to your attention that crude oil price may not necessarily mean corresponding prices for refined products. The international oil market is faced with severe underinvestment in downstream sectors, too. In the United States, no refinery has been built since 1986. In the European Union, refineries with 7.5 mb/d of refining capacity have shut down permanently. The reason was environmental policies and climate change advocacy pursued by governments.

Food prices are high. War in Ukraine is a major factor to be blamed, but even prior to the conflict, fertilizers’ prices had begun to soar. There is shortage of fertilizers that is produced from oil in refineries.

Most EU countries and notably Germany were influenced by the Green Parties for most of the last decade. Investment in oil and gas industries were considered and labeled as unethical and out of fashion. Renewables and new sources of energy was the order of the day. European leaders wanted popular vote and public support to hold to power and stay in office.

Underinvestment and marginalizing oil and gas led to stagnant upstream sector and lower refining margins. Oil and gas was considered something of the past and for the less developed countries. As such even while oil prices are going up steadily and oil companies earned a lot, there’s still limited incentive to invest in the oil and gas industries. Most oil and gas companies both NOCs and IOCs prefer to divest their additional revenues outside oil and gas.

As I have mentioned earlier, most of the oil and gas producing nations are Asian. Other than Asian countries, BRICS has now come to play a forceful role in the international economy and monetary systems. Since Europe opted to distance itself from oil and gas industries, Asia and BRICS will emerge as the 21st century economic powerhouse. Energy Diplomacy is going to be the order of the day for the oil and gas suppliers.

By Fereydoun Barkeshli,

Energy Market Analyst

Courtesy of Iran Petroleum

News Code 461874

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