A game changer event in international oil markets

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A game changer event in international oil markets

Prices drop on North Sea glut and Germany’s economic chill

By Sarie Khalid (Energy focus)

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Published: Wed 15 Oct 2014, 11:42 PM

Last updated: Fri 3 Apr 2015, 7:09 PM

Brent crude has fallen $25 a barrel since June. The differential between West Texas and Brent, $10 last year, has narrowed to $3 a barrel. The free fall in oil prices is due to a glut of North Sea oil, Germany’s economic chill due to Russian sanctions. Chinese oil demand has also declined at a time when Saudi Arabia has cut posted prices to preserve its market share against Iraq and Iran, who supply the People’s Republic with almost a million barrels of crude a day.

This is a game changer event in Saudi policy and the world oil market. Saudi Arabia has raised output at a time when the world oil market is glutted, due to African crude displaced by the surge in US demand. Saudi Arabia did not defend the $100 or even $90 Brent level with an output cut or even a hint of an emergency Opec meeting. If Saudi Arabia will not cut output or play the role of swing producer, there is no possibility of an Opec quota cut. Even the geopolitical shocks like Libya’s rival militias or ISIS’s reign of terror has not led to higher Libyan and Iraqi crude supplies in the global spot market. This means a new price war in the world oil market.

There have been several “game changer” events in the world oil market. The birth of Opec in Baghdad in 1960, with Saudi Arabia, Iran, Iraq and Venezuela, was a game changer. The October 1973 war in the Middle East and the subsequent Arab oil embargo enabled the oil producers of the Middle East to seize control of pricing and production (once decided by the Western oil super majors, known as the Seven Sisters). The development of the spot (single tanker cargo) market in Rotterdam and later the launch of crude oil, natural gas, heating oil and gasoline futures on the New York Mercantile Exchange was a game changer. China’s WTO accession and meteoric economic growth that transformed the People’s Republic as the world’s largest consumer of crude oil, was a game changer in the past decade. The failure of Lehman Brothers in September 2008 and the $100 Brent free fall in crude was a game changer. The surge in US shale oil production since 2006 is a game changer. Sanctions on Russia is a game changer. The global balance of power in energy has never been static.

Oil traded at $3 a barrel when President Sadat ordered the Egyptian army to cross the Suez Canal on October 6, 1973. Oil was $12 after King Faisal of Saudi Arabia announced the Arab oil embargo after the war. Oil was $18 before the first protests began against the Shah’s regime in 1978. Oil rose to $45 as the Iranian revolution led to a global oil panic and recession in the West. Oil was $20 before George Bush invaded Iraq in March 2003 and overthrew the Saddam Hussein regime in Baghdad. Five years later, in July 2008, Brent crude peaked at an all-time peak of $148. Oil plunged to $40 six months later as the global banking crisis led to the worst recession since the Great Depression.

Saudi Arabia engineered the largest output cut in the history of Opec, removing more than four million barrels of crude oil from the global market. Saudi Arabia’s role as a swing producer enabled Brent to rise to $100 a barrel two years later on the eve of the Arab Spring. The Libyan revolt caused Brent to spike to $128 when the Libyan revolt against the Gaddafi regime began in April 2011 and Brent spiked again to $115 in June 2014 when ISIS fighters entered the Iraqi city of Mosul. However, when the oil market was sure that ISIS did not threaten Iraq’s oil fields, pipelines and oil terminals in Basra Province, oil prices fell below $100 by September 2014, softening as Kuwait, the UAE, Libya and Nigeria increased production at a time of a glut in North Sea oil and US shale oil production.

How low can Brent crude oil go? Absent a global recession, it is doubtful if Brent crude will fall to $50-60 since shale oil, deep-water drilling and oil sands require a price of at least $85. Moreover, Saudi Arabia’s budget break-even price is $90, a level that the kingdom must defend with a coordinated Opec output cut. However, the new drilling technologies developed in the US mean that the balance of power in global energy will increasingly shift from suppliers to consumers. Even a major Saudi Arabian output cut may not be sufficient to prevent a major crash in crude oil prices. The stakes for global oil markets, the world economy and power politics could not be higher.

Will the pro-democracy protests in Hong Kong lead to another Tienanmen Square crackdown in China? Will Russia escalate its covert military intervention in Ukraine despite the Minsk ceasefire? Will Vietnam and China’s maritime dispute over oil drilling in the South China Sea lead to another war between Hanoi and Beijing? Will Nigeria survive the Boko Haram insurgency as Africa’s economic superpower? Will the US and EU lift anti-nuclear sanctions on Iran? Will Saudi Arabia abandon its role of swing producer in Opec? Will Iraq survive as a sovereign state? The global oil market’s fate hinges on the answers to all the above questions.

The US Energy Department estimates US production will reach 9.5 million barrels a day by 2016, almost double its 2007 rate. This is an economic event of global historic importance because it makes a major oil price decline inevitable in the next two years, as the Federal Reserve has reduced its monetary easing and the US dollar has soared against the euro, yen, sterling, rouble and Asian currencies. Hydraulic fracking led to the US becoming the world’s top natural gas producer.

However, shale also led to a 70 per cent fall in Henny Hub natural gas prices. As the US exports LNG to Europe and Asia, a major collapse in LNG prices is possible. This will be an economic catastrophe for Russia, Iran, Qatar and Algeria.

The writer is a Dubai-based research analyst in energy and GCC economics.

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