Oil prices defy expectations
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.