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Simon Watkins

Simon Watkins

Simon Watkins is a former senior FX trader and salesman, financial journalist, and best-selling author. He was Head of Forex Institutional Sales and Trading for…

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The Real Reason Oil Prices Aren’t At $80

The UAE’s awarding last week of a slew of huge drilling contracts aimed at increasing its crude oil output capacity from around 4 million barrels per day (bpd) to 5 million bpd underlines that the principal market risk from an oil trader’s perspective is still skewed towards further supply against a backdrop of an uneven bounce back in demand following the height of the global COVID-19 crisis in 2020.

In the short- and medium-term, significant supply increases are likely to come from ongoing failures in the OPEC decision and implementation structure, and in the longer term from a potential flood of new crude from Iran in the official oil markets and increases from non-OPEC crude producers.

This trader-centric view is the basic reason that, despite the huge recent buying in the crude oil market by some leading investment banks and their fund manager clients (and their frantic bidding of oil on dips) with a view to hitting the much-vaunted US$80 per barrel point, crude has failed to meaningfully threaten that level or the once-steady US$100 per barrel price that prevailed for years before the Saudis launched the 2014-2016 Oil Price War.

This inability to threaten these key price levels is also a function of the political reality that, however much the supposedly environmentally-friendly U.S. President Joe Biden might, in theory, be happy to see oil prices go higher to narrow the retail pricing discrepancy between it and more ‘green energy’ alternatives, in the cold light of political reality the fact remains that he is acutely aware of how damaging for any presidency such a price rise would be.  As was very clearly demonstrated under the government of former President Donald Trump – but pertains to all U.S. presidencies of recent years – the top person in the White House does not, in general, want oil prices on the higher side. The economic reason for this is that for every US$0.01 that the U.S.’s national average price of gasoline rises, more than US$1 billion per year in discretionary additional consumer spending is estimated to be lost.

As a general historical rule of thumb, it is estimated that every US$10 per barrel change in the price of crude oil results in a US$0.25 change in the price of a gallon of gasoline. Based on more recent historical precedent, a US$90-95 per barrel of Brent oil price equates to around US$3 per gallon of gasoline and a US$125-130 per barrel of Brent equates to around US$4 per gallon of gasoline. The ‘danger zone’ for U.S. presidents starts at around US$3.00 per gallon and at US$4.00 per gallon they are being advised to pack their bags in Pennsylvania Avenue or start a war to divert the public’s attention. The point was underlined by Bob McNally, the former energy adviser to the former President George W. Bush that: “Few things terrify an American president more than a spike in fuel [gasoline] prices.” 

Related: Can The Airline Industry Live Without Fossil Fuels? This is the key reason why an unofficial White House oil price cap of around US$75-80 per barrel of Brent has operated since the end of the 2014-2016 Oil Price War. On the only notable occasion when the Brent crude oil price rose significantly above the US$70 per barrel level for any sustained period and looked like threatening the cap - in the second half of 2018, with the Saudis ramping up prices in concert with Russia - President Trump sent the first threatening message in a speech aimed at the Saudis.

The message made clear that in the U.S.’s view Saudi Arabia was contravening the foundation 1945 agreement on Bitter Lake between Roosevelt and Abdulaziz and, therefore, put at risk the U.S. support of the Al-Saud ruling family as the monarchy of Saudi Arabia. This came shortly after a similar comment from Trump in a speech before the U.N. General Assembly: “OPEC and OPEC nations are, as usual, ripping off the rest of the world, and I don’t like it. Nobody should like it,” he said. “We defend many of these nations for nothing, and then they take advantage of us by giving us high oil prices. Not good. We want them to stop raising prices. We want them to start lowering prices and they must contribute substantially to military protection from now on.”

Oil’s inability to break these key levels is also a significant reason why the U.S. shale oil sector producers and their Wall Street backers are under no government pressure to ramp up production right now. If Brent crude oil started to rise decisively above the US$80 per barrel level for a sustained period and looked like it was heading for US$90-100 per barrel, though, this status quo would likely change very quickly. At the same time, huge pressure would be brought to bear by the White House on Saudi Arabia and the rest of the OPEC producers to increase production and lower oil prices, as has been highlighted repeatedly by OilPrice.com.

Aside from the domestic political reasons why the U.S. government is happy to accommodate a big increase in the UAE’s crude oil output capacity in a relatively short time, the Emirates’ ambition also aligns perfectly with Washington’s new policy in the Middle East as a whole, which began with the ‘relationship normalization’ deals forged between the U.S., Israel and various Arab states in the last days of the presidency of Donald Trump.

In its most basic terms, this policy is aimed at engaging with anchor Arab states that are not already too tied into the rampant China-Russia-Iran power axis, whilst also trying to at least partially loosen the grip of Beijing and Moscow on Iran (and therefore Iraq). If the policy is successful – although the part of it relating to Iran and Iraq seems also certain to fail despite clearly being worth a try – the U.S. will also be able to further reduce any significant dependence on Saudi Arabia, at least whilst it is under the control of Crown Prince Mohammed bin Salman. In all eventualities, though, the UAE is vital to the U.S. plans, which is why it was one of the first countries to be approached for the normalized relations program. 

Related: Oil Dips After EIA Reports Crude Inventory Build

Since that point, the UAE has broadened and deepened its relationship with India – which the U.S. is sponsoring as the prime regional political and economic alternative to China – embarked on a huge economic expansion project (‘Operation 300 Billion’), established a new global benchmark trading platform for its oil (ICE Futures Abu Dhabi platform) in partnership with the U.S.-based Intercontinental Exchange, and begun to expand the Fujairah oil export hub as a counterpoint to Iran’s new Goreh-Jask oil export route.

More broadly, the UAE has also removed the previous impediments to the speedy realization of its oil ambitions by reorganizing its Supreme Petroleum Council and has increased its activities as part of a joint intelligence initiative between the UAE and Israel (and, by extension, the U.S.) of the purchase of commercial and adjunct residential properties in Iran’s southern Khuzestan province. The area is a vital hub for Iran’s oil and gas reserves and the influx of UAE-registered businesses, particularly those based in Abu Dhabi and Dubai, but in large part funded by Israel, provides a forward operating platform for various ongoing intelligence-gathering operations. Building on this, last month saw a landmark US$510 million deal with Italy’s Saipem to expand the capacity of the UAE’s flagship Shah Sour Gas Plant, which will ensure that the UAE becomes self-sufficient in gas. This is aimed at safeguarding it from any external pressure that might be brought upon it by the big gas powers in the region, notably Iran, were it to lack this self-sufficiency.

Exactly the same theme of major contracts being given to companies of countries supporting the U.S.’s new policy in the Middle East is seen in the awarding last week of US$764 million in drilling contracts aimed at boosting crude oil output to 5 million bpd as soon as possible on or before 2030.

The UAE’s principal oil firm, the Abu Dhabi National Oil Company (ADNOC), through its Offshore trading unit, awarded the contracts to U.S. companies Schlumberger, and Halliburton, in addition to its own ADNOC Drilling. The contracts will provide integrated rigless services across six of ADNOC Offshore’s artificial islands in the Upper Zakum and Satah Al Razboot fields, according to ADNOC. “These important awards for integrated rigless services will drive efficiencies of drilling and related services, and optimize costs in our offshore operations as we ramp up our drilling activities to increase our production capacity and enable gas self-sufficiency for the UAE,” concluded ADNOC Upstream’s executive director, Yaser Almazrouei, last week. 

By Simon Watkins for Oilprice.com

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  • Mamdouh Salameh on July 22 2021 said:
    The author seems to be lost in his rigmarole that he missed the real reason why crude oil prices haven’t yet touched $80 a barrel.

    The real reason is due overwhelmingly to the global oil market weighing the implications of the new OPEC+ deal and to some extent profit-taking by oil traders.

    Still, Brent crude will soon resume its surge towards $80 underpinned by a global economy growing at 6.3% this year or more than double its rate of growth in 2019, a surging global oil demand, the end of glut in the market and China’s insatiable thirst for oil.

    The impact of OPEC+’s decision to return to the market the reminder of the 9.7 million barrels a day (mbd) by the end of 2022 is as momentous as its decision in April 2020 to cut 9.7 mbd from its production to support oil prices and stabilize the global oil market.

    The OPEC+ deal was a textbook achievement of compromise and farsightedness as it puts a lid on any impasses inside OPEC+ for some time into the future, ensures enough supplies to satisfy the global economy and prevent a supply deficit in early 2022 and gradually returns to the market the remainder of the 9.7 mbd production cuts that OPEC+ made during the height of the pandemic to save the global oil market and prices from collapse.

    OPEC+ has so far been managing the global oil market brilliantly. It will ensure that there is no return to glut now or in the future.

    Still, oil prices will very soon resume their surge with Brent crude headed towards $80 a barrel during the third quarter of this year.

    Aside from the above, The rift inside OPEC+ between Saudi Arabia and the UAE had far less to do with oil and far more to do with the UAE challenging the pre-eminence of Saudi Arabia in the Gulf region and trying to become the closest ally to the United States buoyed by its normalization of relations with Israel and joining the US-Israel-India bloc confronting the China-Russia-Iran bloc.

    It is no secret that Saudi Arabia wasn’t pleased about some decisions taken by the UAE such as withdrawing most of its forces from Yemen in 2019, normalizing its relations with Israel, investing in the Israeli Eilat-Ashkelon oil pipeline (EAP) connecting the Gulf of Aqaba with the Mediterranean and deciding to ship part of its oil exports via EAP. Moreover, Saudi Arabia wasn’t happy about UAE’s attitude towards ending the boycott of Qatar. UAE was disinclined to bury the hatchet.

    Saudi Arabia showed its pleasure about the UAE getting closer to Israel by amending on the 5th of July its rules on imports from other Gulf Cooperation Council (GCC) countries to exclude goods made in free zones or using Israeli input from preferential tariff concessions in an apparent challenge to the UAE’s status as the region’s trade and business hub. The UAE and Israel signed a tax treaty last May as both sides work to spur on business development after normalising relations.

    While political differences between the two countries will pop up every now and then, a sharing of influence in the Gulf region could ensure a peaceful and fruitful cooperation between them. Accordingly, UAE should acknowledge unreservedly the per-eminent status of Saudi Arabia in the Gulf region. In return, Saudi Arabia will acknowledge that the UAE is the business hub of the region.

    In the final analysis and against a background of excessive pressure on the global oil industry to divest of its oil and gas assets and the fact that international oil companies (IOCs) are finding it extremely difficult to replace their oil reserves because of resurgent resource nationalism, the Arab Gulf producers, Russia and Venezuela will be the ultimate suppliers of oil to the world.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London

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