Oil markets could be heading for a possible showdown this week, as U.S. sanctions on Iran will be implemented fully, OPEC+ producers have opened the valves and the global economy is showing some cracks.
In the meantime, reports are emerging that a possible oil glut is again on the horizon, as demand growth could be fledgling. These possible doomsday scenarios are again showing a possible herd-mentality in the press. Even that the so-called OPEC+ production cut agreement has been very successful lately and global oil storage volumes were on their way down, the market is envisaging a possible new tsunami of oil flooding the markets.
However, several main issues could ease the bearish impact of this news in the next two weeks. The effects of the Iran sanctions may already be fully priced in, but looking at the current market situation, most of this could be distorted. Not only is OPEC+ sticking to its official compliance rates, producing enough crude to supply the current demand, but Iran is going full throttle to reap, what could well be the last financial rewards for some time to come. By producing and exporting all Tehran can get on its vessels, part of the current perceived oil supply is just going to be temporary, and without the help of European and Asian customers, Iranian exports will fall to historically unprecedented levels. The last surge in Iranian oil and petrochemical exports is to be expected to hit the market within the next 2-6 weeks, after that the options to close oil deals with Tehran will be very limited.
It also has become clear that OPEC+ has silently agreed on a strategy to not to get into an open conflict with Washington. The continuing calls and tweets coming from the White House, pushing for additional oil on the market, have been heard by Riyadh, Moscow, Abu Dhabi and others.
The power of U.S. president Trump should, however, not be overestimated. Washington doesn’t have the teeth at present to force major oil producers such as Saudi Arabia, UAE or Russia to produce more. OPEC+ members are willing to open up their taps not due to Washington’s political views, but only to reap the financial rewards of the extremely high demand in Asia and elsewhere. Neither Riyadh, Abu Dhabi nor Moscow expect a new oil glut in the near future when opening the taps today.
At the same time, Washington is doing what some Arab countries have asked it to do, block the expansion of Iran in the Middle East by strangling its economy. Until November 4th at least Saudi Arabia and the UAE will be supporting Washington in these efforts. By opening up the taps, Donald Trump’s Grand Old Party (Republicans) is not facing a direct election defeat by the Democratic Party.
If OPEC+ would have stuck to their production cut agreement, targeting higher revenues only, Trump would have had to face the wrath of the majority of U.S. motorists coming days. Iran sanctions, Khashoggi or Russia’s cyber war against the West is just a side note in local U.S. media in relation to the perceived economic damage of high gasoline prices. U.S. voters are voting not with their hearts but with their car keys. Saudi Arabia and Russia have understood that by keeping prices at a lower level at present, supported by additional Iranian oil and the US-China trade war, Trump’s GOP victory in the upcoming elections on November 6th is more likely than at a time of high gasoline prices.
Even though the media is portraying the relationship between Washington (Trump) and Riyadh or Moscow to be fabulous, this needs to be taken with a truckload of salt. It is a marriage of convenience. A strong Trump administration, with the support of Congress and Senate, is of strategic importance to Moscow and Riyadh at present. The latter two have understood that on the short term, reasonably ‘low’ oil prices will beneficial for all. Stable global economic growth, lower unemployment figures in the U.S., low gasoline prices, in combination with the implementation of U.S. sanctions on Iran, will be needed to convince the audience in the U.S. mid-terms.
In two weeks this picture however could change dramatically. The implementation of U.S. Sanctions on Iran and a persistent Trump administration could give enough space to maneuver for OPEC+ on the oil production front. The perceived threat of a new oil glut, as even the IEA has warned, in 2019 will not be taken as a fact of life by Russia, Saudi Arabia and the rest of OPEC. A repeat of the last years is not at all in the interest of the global oil giants.
Some indications of a new strategic turn have already been given by Saudi Minister of Energy Khalid Al Falih and others. OPEC officials have openly stated that the ongoing cooperation within the NOPEC framework will not only become a normal fact of life, but will always include the option to address oil production volumes. If the market is threatened to be flooded, even if Iranian volumes are taken out, OPEC+ will be implementing all necessary measures to counter this. For most oil producers, the main leading theme the coming years will be to set up a stable market in which volumes and price levels are receiving the highest rewards.
In stark contrast to the perceived financial targets of OPEC+ by Western media, higher revenues are not needed to spend outside of the energy sectors, but to sustain current production volumes and to increase future production to counter expected demand. Without higher oil prices these goals are not achieved by any of the NOCs. Without a multi-trillion US$ investment spree the coming years, oil production will not be able to counter future demand levels.
Looking at the current situation, OPEC+ will slowly but without any doubt, set in place a new production cut agreement, most probably just after November. Some facts will emerge just before the OPEC meeting in December, but looking at some of the statements made by Khalid Al Falih, Barkindo and others, a new era of cuts or lower additional production is imminent. If these are not put in place, 2019 could become a very instable and potentially threatening oil and gas year. Without stability, OPEC and others are not going to be able to invest sufficient money in new production. Whatever Washington will be tweeting after November 6, OPEC will probably not be as interested as they are now.
Instead of expecting lower oil prices in 2019, based on the signals received from financial institutions, investors should be bracing themselves for the opposite. OPEC’s full throttle production approach at present will not be in place for longer. There will be no need to comply to requests anymore. Saudi’s spare production capacity is at its lowest since years, and the reality could well be that Saudi oil fields are hurting as a result of the current production strategy. For OPEC, oil is a lifeline, economically and politically. Short-term gains, ruling Western investors and analysis, are not included in Saudi-Russian energy and economic strategies. The highest potential yield decides the outcome, not Western politics or Iranian sanctions.