A phrase thrown “en passant” by Gabriel Obiang, Equatorial Guinea’s Minister of Mines, Industry and Energy at a June 6 conference in Cape Town was telling. The minister proposed that fellow African oil producers band together to protect the value of their oil resources and join OPEC. As more discoveries are made across the continent, cooperation among producers is key, Obiang argued.
Equatorial Guinea is OPEC’s newest member, joining the organization in May. Although small, the country is sub-Saharan Africa’s third largest oil producer, after Nigeria and Angola. Like other oil-rich nations, including top exporter Saudi Arabia, Equatorial Guinea is preparing for a world where energy demand moves away from crude. “If in 10 years, oil becomes a commodity that the developed countries don’t want — they want to focus on just gas, solar — what are the African countries going to do? It’s very important to know what our brothers, our bigger brothers in the region, what Nigeria is doing, what Algeria is doing” and communicate that throughout the continent, the minister said.
The minister’s blunt call inspires the idea of a general restructuring of OPEC in a way that enables all willing producers, including US shale producers, to join together to defend the market and reach a favorable environment in terms of pricing and investments.
There are two reasons to consider such a restructuring.
In terms of prices, we know that prices will not go higher any time soon, and the low prices hurt all producers, without exception. The U.S. shale-vs-OPEC-cuts tale has been the predominant theme in oil markets this year, and, like the cartel’s output cut, it will be rolling over into next year as well.
Major banks — the same ones that at the time of the initial OPEC deal saw the markets tightening and glut eliminated as soon as the second or third quarter this year — have started slashing their oil price forecasts for this year and next, as the six-month OPEC deal failed to rebalance the markets and cuts were extended into March 2018.
U.S. shale production is expected to continue growing through this year and into next year. Meanwhile, JP Morgan believes OPEC’s extension deal has an exit strategy, with the cartel not communicating its end game.
“Neither the length of the extension, nor the compliance rate of its participants, concerns me as much as OPEC’s lack of an exit strategy. If OPEC really has the courage behind their convictions, then the optimal decision would have been to extend cuts through the end of 2018,” Ebele Kemery, head of energy investing at JP Morgan, said on the day in which OPEC announced they would roll over the cuts. Moreover, major investment banks hastened to revise further their oil price projections, seeing a flow of supply hitting the market as soon as production cuts expire in March 2018. Add the second U.S. shale boom to this, and it looks like the glut will return with a vengeance in 2018.
Goldman Sachs cut its Brent price forecast for this year to $55.39 per barrel from its previous estimate of $56.76 a barrel. It also revised down its WTI projections to $52.92 from $54.80 a barrel. Just days before that, Goldman said that it sees the oil glut returning after OPEC’s deal expires. For 2018, it was JP Morgan that made the most drastic cut to its oil price projections, expecting not only U.S. shale to continue roaring back at OPEC, but also the cartel’s deal falling apart by the end of this year. JP Morgan slashed its 2018 WTI forecast by $11—from $53.50 to $42. The price projection for Brent was also axed, by $10, from $55.50 to$45.
“We assume that the OPEC/non-OPEC deal collapses at the end of 2017, as cheating becomes untenable for core OPEC members. Consequently, the 2018 oil market balance now points to rapid builds in inventories which, absent continued OPEC support, should depress oil prices,” David Martin, executive director at JP Morgan, said in the bank’s note, as quoted by Business Insider Australia.
On the other hand, demand is set to increase sooner or later. The International Energy Agency currently forecasts an increase in global oil consumption over the next two decades, and has outlined alternative scenarios in which fuels such as natural gas could displace about 13.5 million barrels of demand by 2040, while efficiency gains and a move to electric cars could remove millions more. An organization such as OPEC is vital in supporting oil producers as the energy landscape changes, according to Equatorial Guinea’s Obiang.
There will always be some common ground between OPEC members, as producers, and the rest of the producers. Both groups have the same concerns and the same interests. With some effort, they can find more common ground, instead of perpetuating the current fruitless war. Coordinating with Russia to reach the recent output cut could spur coordination among all producers, based on shared concerns and interests.
It’s an idea worthy of debate.
Anwar Al Taqi – Esam Aziz
Since Sykes-Picot, oil resources have been the decisive factor in forming the Middle East’s political-strategic map. In the recent history of the region,it’s clear that the oil shock of 1973 was the turning point that gave each of the different actors and states in the region their relative weight, and gave the entire region its global weight.
Now, we see oil is going through a metamorphosis. It may be too slow to be detected by our eyes, nonetheless, it is happening in earnest. “Black gold” is both losing its rarity and slipping away from the region. In other words, the portion of the region’s production in the global output is slowly retreating as the centers of production and exportation are increasingly diversified.
This implies that the region’s internal structure, in terms of relative weight, will also gradually change, and its place in global strategies will be slowly revised with the passing of time. But the result of this paradigm change in the Middle East shows itself first of all as a fiscal problem, with principle producers all dependent on oil as the main source of state revenue.
During the three years covering the period from January 2014 to December 2016, Middle Eastern oil-exporting countries’ revenues fell by an average of more than one-third — or 15% — of GDP, and their current account surpluses have swung violently to double-digit deficits. Notwithstanding a small recent uptick, most forecasts predict that oil prices will remain at current levels in the long term. If so, this will deliver a macroeconomic shock of historic proportions, profoundly changing the Middle East.
An increasing number of the region’s producers are joining the list of countries sliding lower on the scale of fiscal rating. They mostly started programs to cut expenditures, borrow, and draw down their reserves. But countries with large external imbalances, low reserves, or high debts will increasingly feel financially constrained, if they don’t already. Low oil prices will hit Algeria, Bahrain, Iraq, Iran, Oman, and war-torn Libya and Yemen before the richer countries of the Gulf Cooperation Council. Ultimately, however, each country’s economic fate will depend on the choices that it makes today.
What are the prospects of near to mid-term financial stability? Fortunately, the region is better positioned for a growth takeoff than it was in the 1990s, owing to major education and infrastructure investments during the last decade of high oil prices. But to avoid deep cuts to current consumption, any credible growth strategy will have to put structural reforms before even macroeconomic stabilization, lest failure to deliver growth leads to a financial crisis and even deeper consumption cuts in the future.
The main enemy of the region in this context comes from the difficulty of changing the habits formed when oil prices were high. But it is now becoming a Macbethian moment: to be or not to be. There is no room for delay, hesitation, or “waiting for Godot.” Apart from Saudi Arabia, which embarked on a 2030 reform and restructure program, and the UAE, which is the pioneer on this path, signs of change are not yet detected in any considerable fashion.
As occurred in the 80’s, but in larger proportion, the region’s governments today have tied oil revenues to consumption subsidies, public-sector employment, and public investment. When adjustments are needed, they generally take the form of fiscal cuts, rather than structural reforms. And these cuts have mostly hit public investment, thus undermining future growth prospects. Now that oil prices have plateaued, private investment is falling, domestic firms are idling, and unemployment is rising.
However, economic reform raises the possibility of a serious threat to internal stability. Stronger economic growth, though desirable, requires regimes to take risks that could endanger their very survival. Decoupling oil revenues from public subsidies will require a new social contract that is based less on guaranteed consumption and more on personal autonomy. While a diversified economy presupposes more space for private enterprise, governments in the region, especially during boom times, have tended to favor politically connected firms, and blocked those they view as a threat. This practice has always impeded competition, distorted bank lending, and reduced economic dynamism. But, it has helped autocrats preserve their power.
The real fear now is that some countries will be tempted to stick with the status quo, hope for a recovery in oil prices, and crack down harder on civil society in the meantime. If that happens, the situation could turn out even worse than in the 1990s. The region’s people have grown even more accustomed to high levels of state spending, and the public discontent revealed by the Arab Spring has not disappeared. Oil prices will not rise in any substantial way in the midterm future. The other way around is to explain to the population the nature of the problem and to distribute the burden, based on income, to the population, without exception.
The countries that choose reform will need not only political courage, but also well-crafted policies. In most Middle Eastern countries, labor market participation is now among the lowest in the world, and energy-to-output ratios are among the highest. To increase productivity while preserving social stability, subsidies should be removed with the goal of improving efficiency, not simply to make fiscal cuts. And a new fiscal-transfer system should be established to support investment rather than consumption.
Those who opt for reform should receive all the assistance they need from the global community, not only on skills and advice necessary to avoid any social shock, but also in financial terms if needed.
A higher degree of illicit volatility in the global energy market appeared in the week after Saudi Arabia, Bahrain, the UAE and Egypt broke diplomatic ties with Qatar, accusing the country of backing terrorism activities; U.S. crude -0.9% at $47.23 per barrel, Brent -1% at $49.44 and natural gas – 0.2% at $2.99. Market participants will be watching to see if OPEC member Qatar attempts to disrupt the oil production deal, but the country is not a major oil producer, accounting for ~2% of OPEC’s output and shipping 618,000 barrel per day in April.
However, Qatar is the world’s largest exporter of liquefied natural gas, last year shipping 77.2M tons of LNG, equivalent to one-third of global supply. Only Russia and Iran have more proven gas reserves. The dispute has not caused a direct impact on the regional energy sector so far; gas supplies reportedly are continuing from Qatar through the 3.2B cf/day Dolphin pipeline, a joint venture uniting UAE state-run Mubadala, Total ,and Occidental Petroleum. There has been a slight decline in oil futures. However, this decline is most likely due to other factors, namely the increase in inventories in major industrial nations and the prospects of higher US production through 2018.
Yet, some worrying signs followed this relatively calm first week. Two Qatari LNG shipments, believed to be U.K.-bound, abruptly changed direction in the Gulf of Aden Thursday, raising speculation that the row between Qatar and its Mideast neighbors will spill more broadly into the global gas market. While the U.S. natural gas futures remained more or less stable, U.K. future contracts increased by nearly 4% as the reports began to circulate. The two Qatar shipments were believed to have been headed for Britain’s South Hook terminal, partly owned by Qatar Petroleum.
The report was surprising and raised questions about whether Qatari vessels were able to move through the Egyptian-controlled Suez Canal. About 7 percent of seaborne oil and 13 percent of the world’s LNG is transited through the Suez. European analysts believe that the Egyptian-controlled Suez is operating normally. If that were to change, “That would be a massive escalation. There’s a huge amount of cargo that goes through Suez. If they started blocking shipments from one country, it would go to the sanctity of this as a reliable transit point,” said Helima Croft, CNBC’s Global Head of Commodity Strategy.
The concerns retreated shortly after the story of the two tankers, and prices went down to their normal level. Almost all analysts agree that the crisis with Qatar will not impact the freedom of navigation in the region’s pathways.
Oil prices have not been affected by the situation. Qatar is a big player in LNG but a small player in crude oil, if one excludes its ownership stake in Rosneft. About 60 percent of Qatar’s LNG exports go to Asia, and those shipments do not go through the Suez Canal, according to RBC.
Just immediately after the story of the two tankers broke, Shell altered its shipments of LNG, sending a U.S. cargo ship to supply the Dubai Supply Authority instead of the usual Qatar-sourced shipment. It was reported that the Qatari fleet of LNG vessels anchored off the UAE’s Fujairah port prior to the diplomatic rift had moved out. They are currently offshore at Qatar’s Ras Laffan facility, and the number of tankers anchored there has risen to 17 from seven since the crisis erupted.
Yet, possibilities of future impact from the crisis on the LNG global markets are open, as the crisis may escalate. This factor pushes natural gas buyers to seek greater diversification in sourcing amid potential disruptions from United Arab Emirates ports refusing ships from the country. Buyers will increasingly look to complement their contract-dominated import portfolio with more spot purchases, although these will be smaller in volume. LNG buyers have already been increasing spot natural gas purchases since prices in the commodities complex crashed following crude oil’s 2014 slump.
Despite concerns about disruptions to crucial supplies, the market is currently calm. The situation settled when reports indicate that Qatari ships passing through the key Suez Canal shipping route were not facing restrictions, as this is an international water passageway. Despite earlier concerns, gas shipments are also passing through the Strait of Hormuz between Oman and Iran before moving on to Asia.
What buyers may actually be more concerned about now is the chance of logistical problems. The diplomatic rift has hit gas tankers stopping at the port of Fujairah, a fuel hub, with ships sent to find new destinations as far as Singapore for the task, trade media report, potentially causing delays and adding to shipping cost.
Two points must be mentioned in this context, both of which are hypothetical land marks on a virtual path of escalation between the Arab countries and Qatar. The first is the possibility of the Trump administration imposing sanctions on Qatar under the guise of fighting terrorism. The second is kicking Qatar out of OPEC.
While the two possibilities are farfetched, so far, they could happen if the crisis escalates. No one has raised the possibility of U.S. sanctions on Qatar yet, but if some terrorist attack occurred and were attributed to Doha, this could become an option. On the other hand, the implications of Qatar exiting the OPEC production cut deal would be minimal, given Qatar’s commitment to cut by 30,000 bpd – or by 2.5 percent. Qatar’s exports to leading destinations are also likely to be unaffected. Asia is overwhelmingly the largest beneficiary of Qatari crude and condensate flows, with Japan the leading destination over the last year and a half, swiftly followed by South Korea.
In a previous issue, we explained the differences in the oil and natural gas pricing models. Once more, and very briefly, the oil market is the most interconnected commodity market in the world—the price of a barrel of crude sold in the United States, for example, is within a few dollars of what it sells for in Europe or in Asia. Crude can be loaded on a ship and sent halfway around the world, so producers must pay attention to global supply when they set prices.
This is not the case for natural gas. Natural gas is more difficult to transport, and it is most often sent from supplier to consumer via pipelines, but these routes have geographical and political constraints and can produce bottlenecks. They also can’t cross oceans, which has led to the formation of multiple regional gas markets around the world.