Oil has reached a 4-year low, with the barrel of Brent now under 80 USD for the first time since 2011. The fall was been very sharp, considering the Brent was above 115 USD per barrel as late as June 2014.
Analysts have been puzzled as market dynamics do not fully explain this downward trend.
Observers have been quick to point out that US shale oil has been flooding the market, while global demand has softened. However neither of these trends can fully explain the sharp drop in oil prices. Regional and global political consideration are driving the market, with Saudi Arabia playing the pivotal role.
Brent crude oil futures in USD/barrel in 2014 (as of 14th November, 2014)
Over the summer, analysts have pointed to China as a cause for oil price declines, as the country’s economic growth slows gradually. At the same time, weak US manufacturing data has also helped overshadow the fact that the price decline is as much due to the policy of OPEC producer countries as it is due to lower demand levels.
During past oil price drops, Saudi Arabia was able to offset part of the drop by decreasing domestic production, thereby reducing available oil supply. Saudi Arabia has effectively been the oil market regulator for the past decades and has often sought to work contra-cycle in order to ease the economic impact of tight oil markets for Western consumer nations, and first and foremost its US ally.
According to Marco Dunand, Mercuria’s CEO, OPEC would need to remove 1.5m barrels a day from the market for prices to stabilize and recover. But Saudi Arabia currently has a vested interest in keeping oil prices low as this adversely impacts the profitability of numerous projects across the globe, particularly capital intensive extraction processes such as shale oil, ultra-deep off-shore and small field developments.
In other words, Saudi Arabia has found a way of creating a barrier to entry which protects its market share and long-term economic sustainability.
Beating off the shale gas competition
Saudi Arabia now accounts for less than 700,000 barrels of oil imports to the US. This means that not only is Saudi Arabia at risk of losing one of its historical markets (as has happened to Nigerian crude) but it risks becoming less relevant to its key ally if the US were no longer to depend on Saudi oil.
In an article for the FT, Abdalla El-Badri, secretary-general of Opec, said he expected a reduction in higher cost oil production such as US shale if Brent remained around $85 a barrel. According to analysts this translates to a price of $65-$75 at the wellhead in the Bakken, the region driving the US shale oil revolution.
“With the exception of Wood Mackenzie, who see more efficient drilling methods taking Bakken break-even rates down to $58 and a price of $70 at the wellhead shutting down only 150,000 barrels per day, most observers of the shale oil scene see $80/$85 Brent as a red alert level,” said oil broker David Hufton of PVM, also quoted in the FT piece.
On November 5th, newly published Saudi oil prices for December indicated that US customers would also start benefiting from price discounts, setting off a wave of concern across the US shale investor community.
This sparked Saudi Oil Minister Ali Al-Naimi to deny any intentions of an oil price war. However, he has travelled to Mexico and Venezuela since the price discounts were announced, a move viewed as a way of appeasing tensions with other major producing countries that depend on oil revenue for public budgets.
The geopolitical matrix
The drop in oil prices has been masterminded by Saudi Arabia, together with several of the world’s largest oil consumers.
By keeping oil prices depressed, Saudi Arabia hurts the income of countries such as Iran and Russia, both of which are actively supporting the Assad regime in Syria. Saudi Arabia and most Arab states support this policy as they see it as a way of wearing down Shia ardor.
Assad’s supporters are feeling the pinch.
The fall in rubble, following market sanctions due to Russia’s engagement in the Ukrainian conflict, compounded by the drop in oil prices, is hitting Russia’s revenue very hard. The narrowing trade surplus has naturally been the first indicator to show this trend.
Speaking at the G20 Summit in Brisbane, Vladimir Putin has stated that Russia is prepared for a catastrophic collapse of oil prices, despite the fact that oil and gas production and exports account for 50% of the State’s revenue and 68% of Russia’s total export revenues according to the US Energy Information Agency. Oil and gas exports in 2013 amounted to 355 billion USD.
Putin said Russia’s economy had the reserves to withstand a collapse in oil revenues, but added: “We are considering all the scenarios including the so-called catastrophic fall of prices for energy resources which is entirely possible and we admit it.”
On November 12th, market reports indicated that Russia has been massively buying gold bullion, an indication of the country’s wish to offset the lower trade surplus and thus protect the value of the rubble.
While Western media have been relatively silent on the issue, Russian media have been quick to highlight the drop in prices as a new type of oil war waged by the US and its allies.
Similarly Middle Eastern news outlets have focused on how Saudi Arabia is letting oil prices slide to settle disputes with Iran.
Iran has been less vocal that Russia in recent weeks but has also suffered mightily from the drop in market prices. Bloomberg reported on 30th October that oil revenue was down 30%. This comes as Iran needs to achieve a break-even sales price of $143 a barrel this year to maintain its fiscal balance, according to data compiled by Bloomberg. In other words, international sanctions around the country’s nuclear programme and falling oil prices will lead to deficits and an adverse impact on the country’s GDP following two years of negative growth.
Saudi Arabia’s decision to give China big oil price discounts hurts Iran badly as China is the country’s main buyer of crude. The battle for regional supremacy in the Gulf is also being played out on the oil markets, and Saudi Arabia seems to have the upper hand.
Besides Russia and Iran, the obvious losers are producing countries, such as Nigeria and Mexico, as their income is set to shrink markedly.
At the same time consumer countries have been supportive of this trend. In fact official documents show that Saudi Arabia has been offering oil at discount prices at some of its major customers, including China, India, and since November, the US, causing the WTI oil price index to drop sharply on November 4th.
Western nations also benefit from lower oil prices, as do most developing countries. Egypt for example despite its producer status is a net importer and the decrease in international prices means that households enjoy a drop in gasoline prices, which is welcome in a tense political and social situation.
The fall in oil prices is expected to stabilize around the 80 USD mark, although some analysts expect the barrel to drop even lower, this time responding to declining demand and additional supplies coming to world markets through the projected Keystone XL pipeline bringing Canadian oil to the Gulf of Mexico.
The IEA’s latest Oil Market Report expects the price fall to continue well into 2015. »It is increasingly clear that we have begun a new chapter in the history of the oil markets, » the IEA said, adding that « barring any new supply problems, downward price pressures could build further in the first half of 2015.”
Saudi officials also hold that view…and they are the market makers.
There is an underlying risk to European and Asian consumer nations, however. Long-term, they could become further dependent on a small number of suppliers and investors could struggle to finance the massive investments needed to sustain the projected rise of oil production to over 100 million barrels by 2040, driven mainly by developing nations.
All eyes are now riveted to the next OPEC meeting which will be taking place in Vienna on November 27th. Will OPEC cut back from its current production of 31 million oil per day? All depends on what Saudi Arabia believes is the right price level to achieve its geopolitical goals.
Thomas Esdaile-Bouquet is an international energy affairs expert, having worked on sustainable energy, oil and gas and climate policies and markets for the past 10 years.
An alumni of both the Strasbourg and Bordeaux Institutes for Political Sciences, Thomas has held positions in Washington, Paris, Brussels, London and Geneva, advising consultancies, industry trade associations, UN agencies, ministries and multinationals. He is currently based in Switzerland.
This piece is written in his personal capacity and the views reflected are his own.
Follow Thomas on Twitter: @tomesdaile