From Nick Cunningham: Iran and Saudi Arabia are at odds over what to do next with the OPEC agreement, a conflict that could sow the seeds of the agreement’s demise over the course of the next year.
As the WSJ notes, the dispute centers around exactly what price the cartel should be targeting. Iran’s oil minister has said that the group should not push prices too high because it would likely spark an even greater production response from shale drillers. “If the price jumps [to] around $70…it will motivate more production in shale oil in the United States,” Iranian oil minister Bijan Zanganeh told the WSJ. Zanganeh has suggested $60 is about the right price for now.
Meanwhile, Saudi Arabia, which has much higher budgetary requirements and a desperate need to lift oil prices in order to bolster the valuation of the Saudi Aramco IPO, is unofficially aiming for $70 per barrel. Saudi oil minister Khalid al-Falih has repeatedly dismissed concerns about a shale wave.
Instead, the Saudis are hoping to keep the limits in place regardless of what U.S. shale does, at least for the next year or so. In the meantime, Saudi Arabia is trying to stitch together a more permanent framework with Russia for 2019 and beyond.
With the oil market dipping recently because of surging shale production, inventories are expected to build through mid-2018. That has Brent prices back down at about $65 per barrel, a price that is probably a little too low for the Aramco IPO. As such, Saudi officials have reportedly concluded that the IPO will be pushed off until 2019, after initially preparing a late-2018 offering.
Something like $70 per barrel would be more preferable. But at that price level, the risk is that U.S. gushes oil at even more impressive rates. According to Rystad Energy, U.S. shale would add an additional 600,000 bpd of oil if prices jumped from $60 to $70.
Iran appears a little more anxious to remove the production restraints than Saudi Arabia. Zanganeh told the WSJ that Iran could start pressuring OPEC at its June meeting to bring back some oil production. That could begin to undermine some of the group’s resolve, endangering the pact.
However, the problem with Zanganeh’s logic is that Iran has struggled to really lay the groundwork for large-scale production increases beyond what it has already achieved since international sanctions were lifted at the beginning of 2016. Iran produced about 3 million barrels per day at the start of 2016, and was able to boost output to about 3.75 mb/d within 12 months.
But a lot of those gains came from some low hanging fruit. Future production increases in Iran will require some major investments from international oil companies, something that has been hard to secure for a country that was never able to entirely escape the long shadow of the U.S. Treasury. Now, the Trump administration is ratcheting up the rhetoric and pressure on Tehran, and a growing conflict is a very real possibility in the months ahead.
That has kept foreign capital on the sidelines. The WSJ reported that Iran has only attracted about $1.3 billion in oil and gas investment over the past two years, about a tenth of what it had been aiming for. Only Total SA has committed to new investment in Iran, and that was for a natural gas project. “I am not satisfied,” oil minister Zanganeh told the WSJ, referring to the investment shortfall. “But we are trying and I am optimistic.” But U.S. sanctions will probably limit the pool of candidates for new ventures to some Russian firms.
Still, Iran’s objectives on oil policy are starting to deviate from those of Saudi Arabia. It’s a remarkable change of roles for the two countries. When Iran was under sanctions it badly needed revenue and so it repeatedly pressed OPEC to make higher prices a priority. Saudi Arabia, on the other hand, wanted higher production to hold onto market share. But Riyadh has different priorities now. The Deputy Crown Prince Mohammad bin Salman’s aggressive and costly foreign policy, combined with his major economic reform policies – with the Aramco IPO as a centerpiece – are pushing the Saudis to press for higher prices at all costs.
The question is whether or not the rest of OPEC is willing to continue to restrain output while U.S. shale continues to add new supply. By the end of the year, the U.S. is expected to top 11 mb/d. To add insult to injury, some of that new production will be shipped to Asia, cutting OPEC’s market share in the region.
That fact could start to undermine the cohesion within the cartel as some members begin to push for the exit on the production cut deal. “We think compliance is likely to slip. The deal will still officially be in place, but once we get into 2019 there’s no chance that we will see some sort of deal,” Warren Patterson, a commodities strategist at ING Groep NV, told Bloomberg.
Then there is the small matter of keeping Russia on board. OPEC is trying to ink a deal with Moscow that extends beyond the current agreement, but Russia will only play along so long as it suits their interests. At some point, Russia’s interests could conflict with OPEC.
“Russia and OPEC have a major problem in the long run. The fact that the Saudis are pegging to the U.S. dollar and the Russians have a floating currency means in the long run the Saudis want more dollars and the Russians want more barrels,” said Francisco Blanch, head of global commodities and derivatives research at Bank of America Merrill Lynch, according to CNBC. “At the end of the day, if the Russians extend the deal into 2020, they lose more market share to the U.S., and I don’t think they’re willing to do that.”
The United States Oil Fund LP ETF (USO) was unchanged in premarket trading Tuesday. Year-to-date, USO has gained 3.00%, versus a 4.37% rise in the benchmark S&P 500 index during the same period.
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