“Oil prices getting lower. Great! Like a big Tax Cut for America and the World. Enjoy! $54, was just $82. Thank you to Saudi Arabia, but let’s go lower!” President Trump tweeted a few days ago.
Trump is a bit confused on the specific figures – perhaps he was mixing up Brent and WTI – but the message to Riyadh was clear. The American president is pleased with the collapse in oil prices and wants them to go even lower, although he’s light on specifics. “It would probably be incorrect to think that Trump has any particular oil price target other than ‘lower’, or a view on what would be a sustainable or even ‘fair’ oil price,” Standard Chartered wrote in a note on Wednesday. “The aim is simply to maximise the gain to consumers.”
The recent meltdown in oil prices is indeed impressive, but for prices to fall even more, OPEC+ would need to take a pass on a production cut. The problem is that the lower prices go, the more likely the group will agree to curb output.
Russia has been coy in recent weeks about where they stand on a production cut. The thinking in Moscow is a bit more cautious than in Riyadh – engineering a price increase, while good for the budget, also risks sparking more production from U.S. shale.
Moreover, Russia’s currency tends to weaken when oil prices fall, cushioning the blow to Russian oil producers and to the Russian economy. Russian firms can pay expenses in weaker rubles, while making oil sales in stronger dollars. Saudi Arabia, with its fixed exchange rate, doesn’t have this luxury. That makes the Saudis a bit more squeamish on lower prices.
However, Brent crude dipped below $60 per barrel on Friday, a level that starts to make even the Russians uncomfortable. As a result, the pressure is on OPEC+ to cut production.
A cut remains the most likely outcome, but Trump’s pressure complicates the calculus. It’s a bit of a flip of the script compared to the June OPEC meeting. Six months ago, several OPEC members – namely, Iran – accused Saudi Arabia of doing Trump’s bidding. Boosting output to lower prices, especially since it was set to come at the expense of Iran due to American sanctions, all at the behest of Washington, was a bad look for Saudi Arabia. Riyadh needed the political cover of having other nations go along with the production increase, and the Saudis went to great lengths to bill the increase as part of an effort at bringing OPEC+ back into compliance after over-cutting. Related: Trump’s Impossible Decision Over Saudi Arabia
Now, the situation is reverse. The glut has reemerged and Saudi officials want a cut to boost prices. But, whereas Riyadh was wary of being seen carrying water for Trump back in June, now there is a bit of a risk raising the ire of the American tweeter-in-chief by pushing up prices. Weakening Saudi leverage is the blowback from the U.S. over the murder of Saudi journalist Jamal Khashoggi. Saudi Arabia’s friends in Washington are dwindling, with the remaining few left in the White House.
As such, Saudi Arabia might think twice before spearheading a major OPEC+ production cut, even as most analysts think that some sort of cut is the most likely outcome. “We expect that OPEC will manage the market in 2019 and assess the probability of an agreement to reduce production at around 2-in-3. In that scenario, Brent prices likely recover back into the $70s,” Morgan Stanley wrote in a note to clients.
Meanwhile, Trump’s interests are not entirely in one direction either. He is boasting about lower oil prices as a gift to American motorists, but there is a bit of danger in demanding OPEC+ let prices fall even more. Lower prices would complicate matters for the U.S. shale industry, which has been growing at a blistering rate this year. Lower is better for consumers, but bad for producers.
“[I]n our view the US oil industry will not be able to sustain output growth at current prices, which, allowing for regional differentials, are close to USD 45/bbl in the heart of the Permian Basin,” Standard Chartered wrote in a note. “Lower prices from here risk the health of the Texan geese that are currently laying golden eggs.”
By Nick Cunningham of Oilprice.com
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Oil prices are volatile by nature given the various economic and geopolitical pressures they come under virtually on daily basis. That is why one shouldn’t be surprised to see oil prices shuttling between bull and bear markets all the time.
The global oil market fundamentals are still as robust as in October when oil prices hit $87 a barrel. The market has had a small pocket of glut then capable of taking care of outages by Venezuela and others. It is true that the small glut may have increased a bit recently to 700,000 barrels a day (b/d) by Libya lifting its oil production to 1.2 million barrels a day (mbd).
I am convinced that oil prices will soon resume their surge upwards buoyed by very robust market fundamentals and Chinese oil imports which have been breaking records in recent times.
OPEC doesn’t have to cut production in its meeting in December. A better idea is for Saudi Arabia and Russia to withdraw the 400,000 b/d and 250,000 b/d they respectively added to the market and return them to the previous 1.8 mbd cut under the OPEC/non-OPEC agreement. In so doing, the glut in the market will be significantly reduced. Libya will also be asked not to raise its production above 1.2 mbd if it is to remain exempt from the production cut agreement.
The news that oil companies have lost an estimated $1 trillion since the oil began its latest slide over a 40-day period since October demonstrate the importance of high oil prices to the global economy.
I have always argued that a fair price for oil ranges from $100-$130 a barrel. Such a price is good for the global economy since it invigorates the three biggest chunks of the global economy, namely, global investments, the economies of the oil-producing nations and the global oil industry.
Still, the slumping oil prices despite US sanctions on Iran proves abundantly clear that the sanctions have so far failed to cost Iranian oil exports a loss of even one barrel. That is despite the fact that the global oil market has been bombarded on daily basis for months prior to the sanctions by projections including IEA’s that the sanctions will cost Iran’s oil exports some 500,000 b/d to 1.5 mbd.
Furthermore, the issuing of sanction waivers to eight countries who didn’t need them in the first place and who would have continued to buy Iranian crude with or without the waivers is the clearest admission by the Trump administration that their zero exports option is out of reach and that sanctions are doomed to fail miserably.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London