The end of the Iranian sanction waivers by the Trump Administration has put oil traders on edge.
While most analysts are optimistic about OPEC leader Saudi Arabia being able to fill the gap left by lower Iranian oil exports, reality could be totally different. Looking at the ongoing discussions between OPEC’s two key members, Saudi Arabia and the UAE, there are no real signs that the Kingdom of Oil will be willing to increase its overall oil production to keep prices at the pump low in oil importing nations.
The real crux at present is what the market will do when, on the 2nd of May, the Iran sanction waivers end. History has shown that oil importers are very well equipped to take mitigating measures to counter the effects of the Iran sanctions. Saudi Arabia, and others, will have to be very careful to stabilize the market without falling into a Trumpian trap, which could result in an oversupply situation in the short term.
At present, all signs point to higher oil prices. If no real additional oil is brought onto the market, shortages will become visible within months. Statements made by U.S. president Trump and U.S. Secretary of State Mike Pompeo that Saudi Arabia and the UAE will add supplies to counter the loss of Iranian volumes are currently only wishful thinking, and not based on any hard promises from Riyadh or Abu Dhabi.
OPEC’s leaders are in a powerful position to react to Trump’s calls for additional volumes and lower prices as they wish. Washington’s strategy may well have backfired, as U.S. shale will not be able to supply the markets with the necessary crude grades. At the same time, national oil companies are willing to take a backseat, as long as OPEC+ production cuts are in place.
For Saudi Arabia, additional production increases are not needed. The current price and production levels are sufficient to support the ongoing economic diversification plans, stabilizing the position of Crown Prince Mohammed bin Salman. Oil market stability has also generated enough positive sentiment in the market that NOCs like Aramco are able to enter the international bond market by force. Low cost financing is an attractive tool for Saudi Arabia and the UAE to boost their economies in the short run.
Western analysts are still addressing the loss of Iranian volumes in the light of OPEC’s spare production capacity. This, however is not a major concern, as the market is well enough supplied for the next months. There’s no real necessity to force Saudi Arabia and the UAE to open up their taps to flood the market. Current crude oil prices are also not at levels that really erode global economic growth. Saudi Arabia and UAE could easily add around 1.5-2 million bpd in the market, but looking at the irrational emotional behavior of the oil market at present, a Saudi output increase could lead to a price slump or worse. The OPEC+ cut agreement is up for review in June 2019, and no moves should be expected before then.
Another major issue is hanging over the market already. Oil importing countries, such as China or India, will use the next couple of weeks to negotiate new oil contracts with Iran. These volumes could partly destabilize the market if other OPEC producers fall into the trap of increasing production to squeeze Iran out of the market. The most sensible approach would be a further tightening of the market resulting in a draw from the still elevated global storage but without creating a shortage.
The Iranian sanctions situation is not going to change Riyadh’s current position. The only unknowns at present are the impact of Libyan and Venezuelan supply outages. A potential loss of Libyan crude volumes could change OPEC’s overall strategy in the short term. The Venezuelan production decline has already has been priced in by most parties.
Riyadh also will be looking at the developments in Russia. Even though Russia is part of the OPEC+ agreement, there seems to be some reluctance to sustain output cuts in Moscow. Russia and Saudi Arabia will need to consider their approach as U.S. shale production could leap higher when prices rise too much. Moscow and Riyadh will have to deal with an increasingly tight market, especially during U.S. driving season, while trying to keep prices in check.
Regardless of this, tight markets are much more important for OPEC+ than a happy Trump Administration is. Price levels between $70-80 per barrel will not cut into economic growth dramatically, while the coffers of OPEC members will be filled. Trump’s tweets such as the one on Friday will likely fall on deaf ears.
OPEC also will also be able, without officially ending it production cut agreement, to supply additional volumes to the market in order to keep prices within certain boundaries. Saudi Arabia, for example, could increase production by another 500,000 bpd without going over its OPEC-imposed quota. If OPEC members, and Russia, are able to constrain their own eagerness to take over Iran’s market share, the market will be kept stable for longer. No news should be expected ahead of the June meeting in Vienna, not even during the OPEC+ ministerial monitoring meeting on May 19th. Trump will soon need to find a way to explain to his voters why he can’t keep gasoline prices in check.