Oil prices defy expectations

Sunday 29/05/2016
A worker checks the valves at Al-Sheiba oil refinery in the southern Iraqi city of Basra.

Beirut - Oil prices have increased since the first quar­ter of 2016, climbing from $27-$30 a barrel to $45-$49 a barrel. Fore­casts following the Doha accord to freeze production levels to those of last January reached between the Organisation of the Petroleum Exporting Countries (OPEC) and non-OPEC producers envisioned a free-for-all collapse of prices as Iran repudiated the draft agree­ment by Saudi Arabia, Russia, Ven­ezuela and Qatar.
Doomsday predictions were made as Saudi Arabia then refused to sign the accord, demanding that all producers — particularly Iran — should also sign. The Iranian-Saudi dispute did not bode well for an intra-OPEC consensus, particular­ly for the forthcoming ministerial conference in Vienna.
Consequently, predictions were made that prices would fall to $10 a barrel. Instead, prices made a U-turn and started heading towards $50 a barrel.
Why did prices change course? While producers could not agree on reducing production, circumstanc­es outside their control reduced substantive supplies from the glob­al markets.
It started with a three-day strike by Kuwaiti oil workers, reducing supplies 2 million barrels per day (bpd). This was followed by Shell declaration of force majeure on 1.4 million bpd of Nigeria’s Bon­ny Light production. Wildfires in Canada caused the shut-in of 1.2 million bpd of production capac­ity. Venezuela and Libya saw lower oil production because of domestic political turbulence.
Also, non-OPEC production is more than 800,000 bpd lower than this time last year, mainly due to a reduction of non-conventional oil (shale oil) in North America.
On the demand side, India’s has shot up due to better industrial performance. India’s oil demand was up 400,000 bpd year-on-year, representing nearly 30% of global demand increase.
The main threat to the markets during the Doha meetings was Iran’s plan to increase produc­tion to 4 million bpd (the level Iran reached before international economic sanctions). Iran has in­creased production from 3.2 mil­lion bpd to 3.6 million bpd and is expected to reach the 4 million bpd target this summer.
The question is: Can it raise pro­duction much beyond this level and how soon? Can it increase pro­duction significantly without up­stream agreements with Interna­tional Oil Companies (IOCs)?
Iran produced approximately 6 million bpd during the late 1970s before the Islamic revolution. The IOCs were negotiating with Tehran even before sanctions were lifted but there are issues with reaching agreements with Tehran.
Iran’s oil industry is operated and owned by companies linked to the Islamic Revolutionary Guards Corps (IRGC), which is a very close supporter of Iranian Supreme Leader Ayatollah Ali Khomeini.
The relinquishment of oil as­sets to IOCs would be a blow to the IRGC’s domestic influence and the many benefits that senior IRGC of­ficers have. A lessening of their power and influence could cause an imbalance in the domestic Ira­nian political system.
As for the IOCs, financial transac­tions with the IRGC can run afoul of US boycott laws. Despite the long negotiations that have taken place, no upstream agreement has been signed. This delay limits produc­tion levels that Iran can reach in the near future.
Iran has pursued a policy in OPEC in which it would have an equiva­lent production quota to Iraq, which is producing more than 4.6 million bpd, with incremental pro­duction increases expected in the second half of 2016.
If Iran’s production does not reach that of Iraq, it should be ex­pected that Iran would veto a new OPEC quota system. An agreement requires unanimity. The absence of a quota system is one of the main reasons behind the quarrels within OPEC.
Current market speculation ex­pects oil prices to rise to more than $50 a barrel by year-end. Several projections see prices in the $60- $70 a barrel range by the end of January.
Caution is necessary with such forecasts. How soon will Canadian tar sand production resume? How much damage has been inflicted on surface facilities? Shale oil in­dustry executives project that their industry can stabilise production at a West Texas Intermediate (WTI) price of $55 a barrel. They also say they can increase production if the WTI price stays in the $60-$70 a barrel range.
This means that not only most of the non-OPEC production decline would cease but that one should expect incremental supplies back in the market. It is the huge non-conventional oil supplies that tipped the global supply-demand balance and led to the 2014 oil price crash.