While the continuing Russia-OPEC discussions are dominating headlines, with a focus on a possible extension of the oil production cut agreement into 2019, the market is far from stable.
Growing geopolitical tensions, currently stemming from Syria and Iran, have already pushed oil and natural gas prices up. The statements made by the International Energy Agency and OPEC ministers in Paris suggest that the markets may be stabilizing, but these reports may be premature. As OPEC and Russia continue to cut production, crude oil inventories are shrinking worldwide, but a new threat is emerging in oil’s fastest growing market: Asia.
India has been a steady growth market for Middle East and African oil suppliers, but the government has recently vented their displeasure with OPEC’s Asian ‘’premium’’ approach for oil and gas prices. Additionally, China and Russia are looking to quell the power of the petrodollar, further amplifying instability in global oil markets.
Overall, fundamentals are undeniably improving. Kuwait’s oil minister Bakheet Al Rashidi stated during a summit that he expects OPEC to extend the production cut agreement in June, with the possiblilty of said extension continuing into mid-2019, something that will likely be decided at the end of 2018. Kuwait’s views are in line with several main OPEC producers, such as Saudi Arabia and the UAE. Russia, too, seems to be on board with this plan.
OPEC’s optimism about current market developments is growing. OPEC’s Secretary General Mohamed Barkindo stated to the press that OECD commercial crude oil inventories are currently less than 50 million barrels over the five-year average. In 2014 OECD levels were 340 million barrels above. Omani oil minister Mohammed al Rumhy, however, has openly criticized recent statements by OPEC. He warned that the job is not done at all. Uncertainty still persists in large parts of the market. Related: JP Morgan: Oil Prices Won't Go Higher Than $70
Al Rumhy reiterated that OPEC- Russia cooperation is needed to quell any possible stumbling blocks in the market, but also to quell possible new pressure from Asian consumers. Oil investments are still needed to keep production flowing while additional volumes are needed to counter growing Asian demand.
One new challenge for MENA oil producers will be the fact that Asian consumers are starting to work against the so-called “Asian Premium”.
Indian minister of petroleum Dharmendra Pradhan already stated to the press that India, in close cooperation with China and other Japanese consumers, will be pushing for changes to the “Asian Premium” contracts of OPEC. Sanjiv Singh, chairman of Indian Oil Corporation, and Wan Yalin, chairman of China’s oil giant CNPC, will be setting up a strategy to force OPEC to set a new and fairer price for Asian customers. This could be a major blow to Arab and Iranian oil producers, as it could lower overall revenues dramatically.
From an Asian standpoint, the call for change is fair, especially as China, Indian, Japan and South Korea are the main consumers of Middle East oil & gas. The historic approach of an “Asian Premium” was partly based on more costly transportation and high demand for crude and LNG/natural gas in European and U.S. markets. The removal of real competition between East and West of Suez has led to an almost exclusive oil and gas trade strategy between MENA producers and Asian consumers.
Asia’s overall position has increased due to economic growth and soaring energy consumption. When looking at the Asian consumers, it no longer seems fair to pay more for the same product. A possible coordinated price change demand by the Asian Tigers, including India, could put Arab and Iranian oil volumes under increased price pressure.
OPEC and Russia also need to adjust to a new situation in which Asian consumers are no longer willing to pay top-prices for a commodity that could be replaced by alternative energy sources, such as wind and solar. The willingness to pivot to other energy sources should not be underestimated any longer. Asian consumers such as China or Japan could change their energy consumption behavior rather quickly as governmental policy plays a large role in forming the consumption patterns of these countries. Related: The World’s Most Profitable Oil Major
For OPEC, the Asian developments should hold a single message. Further coordination between the world’s largest oil exporters is needed to counter not only U.S. shale but consumer behavior in the rest of the world. A dramatic change in attitude in Asia could be leading to a disaster within years if no concerted efforts are in place in the so-called Russia-OPEC constellation.
Arab producers and Moscow can and will be able to address their concerns with the respective governments in Beijing, Tokyo, Delhi or Seoul. Without a real concerted long-term effort, OPEC is going to lose if Moscow choses to play by its own rules.
OPEC’s joint ministerial monitoring committee, set up by Saudi Arabia, Algeria, Oman, Venezuela and Kuwait, will meet this week in Jeddah. The output curbs should be on the agenda, but “Asian Premium’ discussions also should be addressed. Discussing the market should not be restricted to rig numbers, production volumes or storage utilizations worldwide. Price settings in Asia, ongoing pressure on the dollar denomination of crude oil and gas, and geopolitics should play a significant role in these internal discussions. Prolonging or extending production cuts would be a sign of the Russia-OPEC alliance’s willingness to cooperate, but addressing the other issues could be a first step along a path to an improved power position for the cartel in the future.
Russia-OPEC’s mission is NOT Accomplished. Their ultimate goal is still just a speck on the horizon, and currently there doesn't appear to be a highway to drive on.
By Cyril Widdershoven for Oilprice.com
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OPEC and Russia will continue with the agreement well into the future in order to prevent a return of glut that cost their economies dearly during the period 2014-2016.
The Asian Premium is a function of rising transportation costs and geopolitical risks. The Asian customers who depend on Middle East crude oil supplies to the tune of 75% have no alternative but to accept this premium. They can’t replace Middle Eastern crude oil with imports from the US or Canada for instance. Still, there may be room for compromise particularly that oil prices are surging.
Neither the claim that the Asian premium could derail the OPEC deal nor the other claim that “crude oil could be replaced by alternative energy sources, such as wind and solar” are based on facts.
With the United States imposing tariffs on China and sanctions on Russia, these two strategic partners have every right to retaliate against it by hitting it where it really hurts: the Petrodollar.
The 26th of March 2018 will go in history as the most momentous day for the United States’ economy, China’s economy and the petrodollar and also for China’s status as an economic superpower. In that day China launched its yuan-denominated crude oil futures in Shanghai thus challenging the petrodollar for dominance in the global oil market. And in that very day 15.4 million barrels of crude for delivery in September 2018 changed hands over two and a half hours—the length of the first-day trading session for the contract.
Exactly one week after China launched its crude oil futures, the petro-yuan surpassed Brent trading volume. How long will it take it before overtaking the petrodollar?
Russia and China have stepped up their alliance to a level where the Russian ruble is an acceptable tender at many places in China.
The Petro-yuan could prove to be a momentous game changer for the global energy markets, the global economy and the effectiveness of US sanctions.
It is probable that the yuan will emerge as the world’s top reserve currency within the next decade with the petro-yuan dominating global oil trade.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London