Oil prices rose last week to the highest levels since 2014. What was behind this price surge? Ironically, it was an announcement by OPEC that it would increase production.
Oil prices had weakened over the past month following a call from President Trump for OPEC to increase production in response to rising oil prices. After rising above $70 per barrel in May, the price of West Texas Intermediate (WTI) had dropped back to $65/barrel leading up to OPEC’s June 22nd meeting.
It was widely anticipated that the group would decide to bump output at the meeting. At the meeting’s conclusion, OPEC, in agreement with Russia, announced that it would increase production for the first time since implementing production cuts in November 2016.
But WTI rallied by more than 4% following the announcement. Why? Because the market was underwhelmed by OPEC’s decision.
OPEC announced that it would restore about one million barrels per day to the market, beginning this month. Iran had opposed the move, partially in protest of sanctions from the Trump Administration. In reality, the output increase isn’t expected to exceed 700,000 barrels per day because some members are already pumping at maximum capacity.
Further, this output increase won’t be enough to balance the oil market. The most recent Oil Market Report (OMR) from the International Energy Agency (IEA) projected the amount of oil that would be needed by OPEC through 2019 in order to balance the markets:
(Click to enlarge)
By the end of this year, the call on OPEC is expected to be nearly 1.5 million BPD more than they were forecast to produce. Thus, even if OPEC managed to follow through on the full output increase, it would be insufficient to prevent further declines in global crude oil inventories. Expectations that this production increase won’t be enough to stabilize these inventory levels are the primary driver behind last week’s oil price surge.
Related: How Important Are Egypt’s Gas Discoveries?
Also bear in mind that Saudi Aramco is still planning its IPO. Saudi Arabia would like oil prices to remain elevated, while appeasing President Trump. OPEC’s action potentially satisfies President Trump’s request while ensuring that oil prices remain strong.
Oil prices surged again on news that the U.S. was pressuring its allies not to import oil from Iran, lest they risk sanctions. Iran currently exports 2.9 million barrels per day of crude oil and condensate to Asian and European markets. Even if there is modest compliance with this Trump Administration request, it could accelerate the depletion of global crude oil inventories. That would likely drive oil prices even higher.
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That would also make U.S. oil producers happy. Refiners, on the other hand, would likely suffer. Higher oil prices erode the margins of refiners, resulting in lower profits. So even though refiners welcomed the news on biofuel mandates, the spike in oil prices will probably have a bigger negative impact on earnings in the short term.
By Robert Rapier
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By asking Saudi Arabia to raise its production by 2 million barrels a day (mbd), President Trump shows his ignorance of the machinations of the global oil market. His request to Saudi Arabia was motivated by two factors. The first is to try to give the impression that US sanctions against Iran will lead to a decline in Iran’s oil exports by 1 mbd. The other is that there will be midterm elections in November this year and he did not want high oil prices to undo the economic boost from his tax cuts. These two factors have had some effect on oil prices.
First, Iran will not lose a single barrel from its oil exports as a result of the sanctions. Iran’s trump card is the petro-yuan which has virtually nullified the effectiveness of US sanctions. Major customers like the European Union (EU), China, India, Turkey, Russia and Japan are still committed to continue importing Iranian crude.
Second, it is a myth that Saudi Arabia can raise its oil production to by 1 mbd let alone 2 mbd. Saudi claim that it can produce at least 12.5 mbd if needed doesn’t stand scrutiny. Saudi Arabia’s production never exceeded 10.4 mbd before with almost a million barrels of which came not from actual production but from stored crude oil on tankers and on land. Saudi Arabia is only able to raise its oil production by 400,000 b/d being the amount it cut under the OPEC/non-OPEC production agreement. Moreover, Saudi Arabia’s claim that it has a spare production capacity of 2 mbd is very questionable.
Third, OPEC's promise of restoring 1 mbd to the market will in effect translate into less than 600,000 barrels a day (b/d).
You can forget about the IPO of Saudi Aramco. I am on record saying for the last six months that Saudi Arabia will soon withdraw the IPO quietly altogether as it no longer needs the money from the IPO in view of rising oil prices.
Saudi Arabia withdrew the IPO from international listing a few months ago because of two reasons: one is because its own valuation of $100 bn is far bigger than Wall Street’s and other financial houses’ and also because foreign investors would not even consider the IPO without an independent auditing of Saudi proven reserves. The second is the risk of American litigation.
Listing Saudi Aramco on the Saudi Stock Market (Tadawul) will overwhelm it and could create a serious liquidity problem. That is why Saudi Aramco will not be listed there either.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London
Great comments! Enjoyed reading them.
Terry