Demand equation and China factor

By late 2019, or early 2020, global oil markets faced a total demand destruction. Global oil demand fell by 13.5 mb/d within weeks. According to the OPEC Secretariat report of June 2023, the world oil demand will exceed 103.4 mb/d by the end of the year. This tremendous recovery of demand will be met once the price is right and investors are content that the capital value of investment will be compensated.

This was further discussed and elaborated during the 8thOPEC International Seminar on 5-6 July in Vienna. Participants in the seminar who were more at liberty to express themselves, overwhelming supported OPEC+ decisions to hold back some 2.5 mb/d production for the rest of the year 2023 and with possible extension for 2024. During the discussions, the issue of the demand side was addressed from different angles.

First of all, demand growth isn’t going anywhere anytime soon. Demand will grow well into the second half of the century. The bulk of demand comes from Asia. India and China, as well as many other emerging markets in South East Asia, ASEAN and APAC, Bangladesh, and Pakistan. Of course, Africa is going to be a significant demand driver for oil within the next twenty years. Africa has a population of 1.3 billion with an average age of below 30 and is desperately in need of oil to sustain its development projects. Asia and Africa will be the major consumers and producers of oil by the middle of the current century.

Still, on the demand side, I have got to make a reference to the war in Ukraine and consequent disruptions in gas flow from Russia to Europe. Parts of piped natural gas (PNG) from Russia was replaced by LNG cargoes. However, over 70 percent of energy lost due to disruptions was substituted by oil and oil products. As mentioned by the ex-energy commissioner of the EU, Kardi Stimson, no EU member country trusted that energy from solar or wind could fill up the gap for the missing gas supply from Russia. Of course, for France, nuclear power plants did come to the rescue but other European countries specifically Germany had to import oil products to substitute the lost imported natural gas.

Having said that Europe had to build a new refined products portfolio for industrial, as well as household consumption. Germany imported a massive quantity of LPG and oil products obtained from light crude oil. Germany’s import of Norwegian crude oil was more than doubled by the end of the second quarter of 2023. This trend will have to be continued in the absence of adequate natural gas imports.

China and India which are currently the biggest importers of Russian crude, resell a large portion of refined products from the Russian crude to Europe to compensate for the loss of natural gas supply from Russia. According to different sources, there are other countries including in the Persian Gulf region that refine Russian crude for re-exports to Europe.

In this piece of writing, I am not going to dig deeper into the demand side. However, I have to point out that green energy, is energy-intensive. Greening of the economy requires no less oil and gas. According to Cipher & Co., a scientific research institute, it is possible to produce steel, not from mining and iron ore but from chemicals. The process allows the production of steel sheet samples with different strengths but the amount of energy that it takes to build one steel sheet of 4/6 meters is highly energy intensive.

It is impossible to talk about demand and not to mention the Chinese factor and its impacts on energy demand. China has been the driver of growth for the oil market since early 2000. China once was and still is the most sought-after for any major oil-producing country. According to China General Administration of Customs statistics, compiled by Bloomberg, the country imported 11.4 mb/d during the first half of 2023, the highest recorded volume of imports by Chinese oil imports. Imported volumes were from Russia, Iran, Saudi Arabia, and Brazil. However, figures for imports from Iran are indicated under a different category.

What makes China an important and highly sensitive market for oil exporters is complications related to the direction of the economy and the consequent oil and energy consumption attributed to the policy. There are doubts about the continuation of export-led economic policies of the last three decades, as against the adoption of a new import-substitution economic policies. Economists have divergent views if China will be willing to continue to be the world’s factory or in case, it is still willing, if the United States of America will still support such policies. As such, each of the policy courses by China will have a different demand outlook for oil imports and consumptions. When Chinese demand grows, most China-based minerals such as copper, iron ore, or lithium go up. Those minerals mostly end up in Chinese manufacturing folds.

During the G20 Summit of the Heads of State in New Delhi, India, on September 9 and 10, where Chinese President Xi Jinping was not in attendance, Western leaders overwhelmingly supported investments and technology transfer to India. Such general support may indicate that Western countries are now willing to replace India with China as the global manufacturing hub. This would, therefore, mean that during the decade ahead, India’s oil consumption will be the engine of growth for the international oil market.

OPEC+ supply cuts surprise

Last year, at this time of year, i.e. September, countries participating in the OPEC+ deal were fighting for $60 per barrel of Brent crude oil. Today on the 20th of September 2023, Brent is comfortable at $94 per barrel and the market is guessing if and when it will go to $100. In fact, for Saudi Arabia and major producers of the Persian Gulf, $100 per barrel is almost already there. Brent crude has narrowed its differentials with WTI and Arab Light crude types and, in some cases, Middle Eastern crude is higher valued than Brent.

The root of the upward trend in oil prices is many folded. As such the roots of the OPEC decision are also divergent. As mentioned before, the OPEC+ decision is certainly the focal factor. In the meantime, what prompted the core OPEC+ members to decide to trim their output is important. As explained by the OPEC secretary general in July in the OPEC international seminar, OPEC and the OPEC+ are highly sensitive towards the inventory and crude buildup by major consumers; namely the United States, China, and India. The three countries have been building excessive reservoirs both onshore and offshore since early 2020 when the international market was soft and prices were low.

In the meantime, the US began to commercialize its Strategic Petroleum Reserves (SPR) which was meant to be used at war and threatened energy security concerns. America wasn’t alone. European countries, Japan, and of course China and India also built up huge inventories to the extent that began to threaten OPEC+ as rivals. It’s not unusual for consumers to store oil when it is cheap and abundant but when it is excessive and market players are at ease about the oil that is readily available for delivery, it pushes the prices further down.

OPEC+ is therefore committed to bringing down the inventories considerably for as long as it may take. According to the IEA estimates, at the current rate of production, inventories will be considerably lower by the end of 1Q 2024. During the 2Q of this year, consumers built up 1.2 mb/d not for consumption but for filling the storage tanks.

In the meantime, it must be noted that the current upward trend in prices is not about physical deficiency, because the cuts haven’t yet affected the actual supply. There’s usually a gap of about three months before the cut today to dig into the inventories since commitments of the last quarter are still valid and operative for the buyers. Therefore, the current price hike is about speculative sentiments. As long as speculative trading is dominant, price volatility will be expected in the market.

The other important consideration by OPEC producers is the role of the US Federal Reserve. While America asks oil producers to be persistent and predictable, the Federal Reserve is neither predictable nor persistent. Federal Reserve has a monthly meeting where the rate of interest is decided. Changes in the rate of interest on the US dollar and US security bonds directly affect the real money that crude oil exporters earn. This is because oil is priced in the US dollar and the value of the currency affects oil exporter’s real earnings. It is not all about the price of an oil barrel. It is important to know what an oil producer can buy with that volume of earnings. That is why an increasing number of oil (and gas) exporting countries opt for oil trade outside the dollar zone. It is also important to note that the global commodity markets are often manipulated by traders and as such there is a gap, sometimes huge between the physical and financial value of oil and other minerals.

Petro-diplomacy

OPEC and the alliance will not have an easy time stabilizing the market. As mentioned above, the US Federal Reserve tries to create a narrative that inflation is under control, employment data is exuberant and the money supply is well-managed. Nevertheless, higher oil prices that are usually reflected at petrol pump stations in the United States indicate a somewhat opposite direction. One reason might be that the US Federal Reserve is often behind the curves but on the other hand the economy seems robust and at peace with higher oil prices.

To be more precise, shale oil is doing well with higher international oil prices. The high oil price is showing its impacts on more investments and better output that support American hegemony as a net energy exporter during a European war that has a devastating impact on the European economies. Let me remind you that the current 2 mb/d cut that Saudi Arabia has advocated is through the end of 2024, meaning that Saudi Arabia is in the business of holding some 2 mb/d as a cushion for global oil markets management.

However, OPEC members are scheduled to revisit quote baselines. That means to say that a quote challenge will be underway within the organization. OPEC is going to address the issue of quota baselines for African members of the alliance in November this year when they meet for the biannual ordinary meeting. Some African members of the organization, most notably Nigeria, Gabon, and Equatorial Guinea already demand higher quotas as their capacity is going up and the production volume doesn’t reflect the actual capacity of the countries. The issue was a source of friction but was resolved during the June OPEC+ ministerial conference and on the sidelines of the OPEC international seminar on 4 and 5 July.

The quota diplomacy for other major members of the organization is going to wait until early 2024. Among the members aspiring for higher quotas, the United Arab Emirates is at the top of the list. The UAE claims a production capacity of over 5 mb/d and demanded a quota adjustment since 2022. Another member asking for higher quota allocation is Iraq.

Nevertheless, Iran is currently under sanctions and exempted from the organization’s quota arrangements; but it has to be noted that Iran’s current official allocated quota is outdated anyway. Iranian quota allocation in OPEC dates back to 2018.

Back in April 2020, OPEC decided to reset the quotas due to the pandemic and the sharp fall in demand for oil. Iranian oil production quota remained unchanged because the country could not produce for exports anyway. Iran’s current output data is estimated at around 3.5 mb/d. Official data is hard to be obtained for obvious reasons but Iran’s case is something that OPEC must certainly address while discussing new quota baselines.

In fact, as for Iran, the organization owes a great volume of lost production quota to Iran by way of higher quota compensation. Iran’s new output is closely watched and monitored by the organization’s Secretariat and calculated into the current production cuts in the organization and the global oil markets. Iran’s output volume and potential are currently the main focus of international deliberations on oil and energy circles. As for OPEC watchers sustainability and stamina to hold a figure close to 4 mb/d is of importance.

Iran Petroleum