OPEC+’s decision last week to increase its collective oil production has surprised many, given the soft outlook for oil prices for the remainder of this year and into next. It is true that the 137,000 barrels per day (bpd) rise from October is much lower than the 411,000 bpd and 555,000 bpd respective increases for the June and July period, and for the August and September timeframe. However, the rise in oil output also means that the group – which comprises the original OPEC members ‘plus’ Russia – is beginning to reverse the second part of around 1.65 million bpd of oil production cuts (announced in April 2023) by eight of its members over a year earlier than had been scheduled. The first part of the 2.2 million overall reductions (announced in November 2023) has been unwound over the past six months. As de facto leader of OPEC+ Saudi Arabia is only one of two countries in the group with significant spare capacity (the other being the United Arab Emirates) the key question for oil and gas markets is: are we heading into a new oil price war (if we are not already in one)?
It is difficult to believe that Saudi Arabia has already forgotten the disastrous economic and political consequences that befell it and its fellow OPEC members following the 2014-2016 Oil Price War that they fought to curtail the threat posed to them by the then-nascent U.S. shale oil sector, as analysed in full in my latest book on the new global oil market order. The threat was real enough certainly, as U.S. shale oil production increased from an average of slightly less than 0.2 million bpd in 2011 to just over 8.7 million bpd in 2014, according to Energy Information Administration (EIA) figures. This was the largest such volume increase since record-keeping began in 1900, and also meant that the U.S. had overtaken Saudi Arabia and Russia as the world’s largest producer of crude oil. There also appeared every chance that OPEC’s strategy – to overproduce oil to crash prices to levels at which many U.S. shale oil firms would go bankrupt — might succeed. After all, the estimates at that time were that the lifting cost per barrel (pb) of oil of these U.S. producers was over US$70 pb of West Texas Intermediate (WTI), while for Saudi Arabia it was the joint lowest figure in the world (alongside Iran and Iraq) or around US$2 pb only. However, the reality was that during the resultant Oil Price War, the U.S. shale oil sector brilliantly reorganised itself into a leaner, meaner production machine capable of lifting barrels in the low-US$30 pb cost region, and consequently much better able to withstand the lower prices caused by OPEC production cuts than were OPEC countries and Saudi Arabia itself.
As a result, according to the International Energy Agency, the 2014-2016 Oil Price War cost OPEC member states lost a collective US$450 billion in oil revenues. Saudi Arabia itself moved from a budget surplus to a then-record high deficit in 2015 of US$98 billion and spent at least US$250 billion of its foreign exchange reserves over that have gone forever. Politically, it meant the loss of any geopolitical prestige that Saudi Arabia had won since its victory in the First Oil Price War – the ‘1973/74 Oil Crisis’, as also fully detailed in my book – which, by default, led to the need to bring into the OPEC grouping oil and gas heavyweight Russia. It also meant the effective end of the 1945 foundation stone relationship agreement between Saudi Arabia and Washington founded on oil supply security for Washington from Riyadh in exchange for political and military security the other way around. As one senior White House official commented off-the-record to OilPrice.com at the end of 2016: “We’re not going to put up with any more crap from the Saudis.”
That said, it is not entirely impossible to believe that these lessons were thoroughly digested by Saudi Arabia and OPEC, as they tried exactly the same strategy with basically the same objective in early 2020, in the Third Oil Price War. Although this also featured some element of market share tussle between Saudi Arabia and Russia, it also ended in ignominious defeat for Riyadh, although it took a lot less time to come. Donald Trump began by warning Saudi Arabia repeatedly that the U.S. would not tolerate any sustained threat to its shale oil sector in speeches, tweets and in the increasingly close-run legislative passage of the ‘NOPEC Bill’. He also directly warned Saudi Arabia’s King Salman bin Abdulaziz Al Saud that the U.S. might withdraw U.S. military support for the Al Sauds, and by extension to Saudi Arabia. With no sign by the end of March 2020 that the Saudis were going to cease the war, Trump told de facto Saudi ruler Crown Prince Mohammed bin Salman over the telephone on 2 April that unless OPEC started cutting oil production – so allowing oil prices to rise – that he would be powerless to stop lawmakers from passing legislation to withdraw U.S. troops from the Kingdom. Oil production consequently went back to where Trump wanted it and stayed there.
The reason why Trump wanted oil prices at the lower end of recent historical averages – and still does — is that gasoline prices are closely linked to them and as Bob McNally, former energy adviser to former President George W. Bush put it: “Few things terrify an American president more than a spike in fuel [gasoline] prices.” In this context, historical data highlights that every US$10 per barrel (pb) or so change in the price of crude oil results in around a 25-30 cent change in the price of a gallon of gasoline, and for every 1 cent that the average price per gallon of gasoline rises, more than US$1 billion or so per year in consumer spending is lost. The political reason attached to this is that since 1896, the sitting U.S. president has won re-election 11 times out of 11 if the economy was not in recession within two years of an upcoming election. However, sitting U.S. presidents who went into a re-election campaign with the economy in recession won only once out of seven occasions. The same pattern broadly applies to the re-election chances of candidates of any sitting president’s party in U.S. mid-term elections as well. Trump may find a way to run again for President, but even if he does not, his Republican Party will want to optimise their chances for another of their members to be in the top job. Crucially, though, Trump — and no other U.S. President – wants oil prices too low either, as they need to be above the breakeven price for most U.S. shale producers. As of now, the recent Dallas Fed Energy Survey suggests that it is around US$65 pb for new wells drilled, but crucially it is much lower for established wells. Consequently, the Trump ‘Oil Price Range’ sits roughly between a US$40-45 pb of the Brent floor (the breakeven price plus a bit of profit for the bulk of U.S. shale oil producers) and a US$75-80 pb ceiling (which ties into historical data showing that a gasoline price of under US$2 per gallon has been most advantageous for U.S. economic growth), as fully analysed in my latest book.
Ultimately, given these key factors and crediting the Saudis with some common sense – which may or may not be well-founded — it seems unlikely that they are leading OPEC into another oil price war just yet. It may well also be that they are not taking their leadership decisions in OPEC, or the wider OPEC+, without consultation with Washington. It is true that the current oil price outlook is bearish, but this could change rapidly and in large part depending on what the U.S. has planned in some key respects in the coming months. For example, oil and gas sanctions against Russia are in the process of being ramped up dramatically – moves which are likely to be expanded and expedited following the recent incursion into NATO’s Polish territory by Russian drones. Similarly, sanctions are also being stepped up against Iran, Iraq, and Venezuela – three more huge oil producers. With potentially large reductions in oil supply from these countries in the short- and medium- term, the current bearish oil price picture could shift very quickly into one where new supplies coming in from OPEC are necessary to keep price pressures down. Such increases – led by Saudi Arabian supply – will also enable the Kingdom to expand its market share, which will partly offset the fall in price per barrel, and accords with the relationship rapprochement seen between Washington and Riyadh since the beginning of Trump’s second term as President.
By Simon Watkins for Oilprice.com
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