The year 2016 risks being even more bearish than oil producers have feared up to now, in terms of prices. A new threat has arisen: that of a trade war between Saudi Arabia and Iran, on an already saturated oil market. (Photo: CNN.com)
The World Energy Weekly (January 11, 2016 issue), published by the Paris-based Petrostrategies consulting firm which carries out strategic and economic research and analysis on the energy industry, reports on the rivalry between Saudi Arabia and Iran and its possible consequences on the oil market in 2016. According to Petrostrategies, Saudi Arabia and Iran could wage a trade war on the oil market in 2016.
The year 2016 risks being even more bearish than oil producers have feared up to now, in terms of prices. A new threat has arisen: that of a trade war between Saudi Arabia and Iran, on an already saturated oil market. The forecasts of a partial re-balancing between global oil supply and demand in the second half of the year could therefore be proved wrong by events. The surplus of supply compared with demand could continue beyond next summer, for not only is Iran likely to have raised its exports by then, with the lifting of international sanctions, but it seems that Saudi Arabia is going to continue raising its exports. This new perspective clearly stems from the latest statements made by the Saudi Oil Minister, Ali Naimi, who on December 30, 2015, said to the Wall Street Journal: “We no longer limit production. If there is demand, we will respond. We have the capacity to respond to demand”. On the Saudi state television channel Al-Akhbariyya, Naimi stated: “The increase in production depends on… the demand of the customers. We meet out customers’ demand. There is no longer a limit to production, as long as there is demand, we have the ability to meet demand”.
Naimi’s stance is due to the fact that a scenario in which only Iran is expected to raise its exports, while Saudi Arabia would see its own exports stagnate, would not be politically tenable for Riyadh, whose current strategy consists of defending its share of the market. Iran would have the chance of taking market shares from Saudi Arabia, as well as boosting its oil export revenues (at equal prices) while Riyadh would see its market share and revenues halt or even shrink. Iran would even be the only OPEC country to significantly boost its oil revenues, with Iraq’s exports not expected to increase this year by as much as in 2015. Saudi Arabia’s current oil policy is already being criticized at home and even within the royal family. If its Iranian rival boosts its revenues and exports in 2016, the Saudi government could be accused of enabling Tehran to fill its coffers and relaunch its economy, just as Riyadh is asking the Saudi population to make efforts via hikes in electricity, motor fuel and water tariffs. Moreover, Saudi Arabia will have to increase its debt load in order to finance its budgetary deficit, while Iran can hope for a gradual exit from the period of economic gloom that sanctions have condemned it to since 2006.
Thus, the Iran-Saudi rivalry seems to be leading to an increase in their oil exports in 2016. Saudi Arabia will embark on this competition – if confirmed – with an undeniable advantage: it has a spare production capacity of around 2 million b/d. It is also hoping that on its domestic market, the latest increases in tariffs will lead to gains in energy efficiency: that could slow down the rate of growth in its consumption. In Riyadh, there is even hope that the Kingdom’s energy consumption will begin to fall. “We expect—from now on — efficiency of energy consumption to increase, which means the energy consumed will be reduced”, Naimi stated. This wish may not be granted for the time being, as even after the rises that have just been decided, energy tariffs remain very low in Saudi Arabia and the possibilities of energy substitution are very limited there, and even inexistent in some sectors, such as transportation.
Iran puts it own spare oil production capacity at an estimated 500,000 b/d. Iranian officials say this capacity could be remobilized “in the weeks that follow” the lifting of sanctions. If a decision is made by the spring of 2016 to go ahead with this lifting, it is reasonable to expect that Iran will significantly boost its exports as of next summer: the first sales will probably come from volumes of crude oil stored at sea and estimated at around 30 million barrels. And if for its part Saudi Arabia raises its exports at the same rate as Iran, one could expect a hike of at least 1 million b/d in OPEC’s production in the second half of 2016. According to the IEA, the call for OPEC crude oil required to balance the market is around 31.9 million b/d in the second half of this year. OPEC’s current output is already estimated at 31.7 million b/d. One could therefore fear that the partial rebalancing of the market expected in the second half of 2016 will fall victim to Saudi-Iranian rivalry.
If this scenario arises, in 2016 the average prices of oil could be less than the levels that had been forecast. The average price of Brent in 2015 was $53.6/b. The UK benchmark crude is currently sold at $35/b. Analysts were predicting a Brent of $40 to $55/b for 2016. It is worth noting that the sudden rise in tensions between Saudi Arabia and Iran last week only triggered a temporary rise of 4% in Brent prices: the price fall resumed within 24 hours. Yet these two countries account for 15% of the world’s exports and control the two banks of the Gulf, with also a strong Iranian military presence in the Strait of Hormuz.
On the other hand, in the case of low crude oil prices, expensive oils could play a more important role as a market balancing factor. If the price of crude oil does not hit at least $45-50/b in 2016, these so-called marginal oils (shale, oil sands, stripper wells etc) will be affected. Their production could therefore fall by even more than the 500,000 b/d expected. The financial situation of most of the producers of these oils has become untenable: their cash flows no longer cover their expenses and the possibilities of raising new funds (through debts or equity) are waning. The number of bankruptcies among small US shale producers is on the rise. The futures price curve remains in contango, with a premium of around $8/b over one year ($42.6/b for the WTI of January 2017, compared with $34.7/b for January 2016).
Producers can therefore protect and cover themselves, but the level of prices has fallen: only a month ago, WTI was listed at $48/b for January 2017.
The partial rebalancing of the global oil market expected in the 2nd half of 2016 appears to be under threat
Could the rivalry between Iran and Saudi Arabia on the oil market continue into the year 2017? In theory, yes. Even if it raises its output by 500,000 b/d in 2016, Saudi Arabia will still have a spare capacity of around 1.5 million b/d. For its part, Iran says it is determined to boost its production by a further 500,000 b/d as soon as possible. Yet the market reaction to a new increase in the output of these two countries might not be a fall in prices. On the one hand, demand will have risen further by 2017. Furthermore, a new reduction in Saudi Arabia’s spare production capacity could give rise to fears on the market. This country retains a security “cushion” enabling it to increase its output in case of emergency, if other countries are prevented from producing. If this “cushion” is considered to be insufficient, a geopolitical risk premium could be added to the price of the oil.
In 2016, for the second consecutive year (the third for some of them), non-OPEC oil companies will have lowered their investments. There will be increasingly fewer production start-ups of fields of which the development was launched before prices fell in 2014. Few new developments will be given the go-ahead because of low prices and the effects of the natural decline of old producing fields (3 to 5% per annum) will be felt by global supply.
The march towards post-oil era is truly underway
Thus, around the 2017 or 2018 time horizon, and in 2018 at the latest, a price hike seems inevitable as a result of insufficient supply. If Saudi Arabia wants to prevent such an increase in prices (in order to pursue its market share strategy), it has to announce a swift rise in its production capacity. The country holds 25% of the world’s conventional oil reserves. Saudi officials have more and more reasons to wonder whether or not all of their oil will actually be produced before the world turns its back on this source of energy. The COP21 climate conference, which was held in Paris in November-December 2015, and the “energy transition” to which more and more countries are committing themselves, give the impression that this time the march towards post-oil era is truly underway. The life span of Saudi reserves (at the current production rate) is around seven or eight decades! Saudi officials are therefore leaning more towards the opinion of economists who believe that oil only has a political and economic value if it is produced. It should therefore be extracted while there is still time, even at low prices, rather than see it remaining trapped in its underground reservoirs until the end of time.
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Iran says it will not seek to “distort” the oil market Iran ensures that when sanctions are lifted and it raises its exports, it will not grant discounts on prices that could weaken the market. “We are not seeking to distort the market but will regain our market share”, said the Iranian Oil Minister, Bijan Namdar Zanganeh, on January 3. The day before, the NIOC’s Director General for International Affairs, Mohsen Qamsari, had told the Iranian Oil Ministry’s Shana news agency: “The decision on the amount of exports highly depends on the future condition of the market. We will raise our market quota steadily”. He added: “We will exercise great caution to prevent a further decline in international prices and will adopt certain methods and strategies to this end”. He pointed out that this could mean that Iran will invest in refineries abroad.
