Oil price volatility: All eyes on the G20 meeting

Dr. Mohamed A. Ramady
Dr. Mohamed A. Ramady
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The global oil markets have been in a state of shock, with price volatility and falls of 7-8 percent in one day becoming a new norm and causing a panic on whether oil prices will fall below another benchmark – the $50 per barrel levels.

The sharp falls had posted a seventh consecutive weekly loss, amid intensifying fears of a supply glut even as major producers consider cutting output.

A bit of a bounce back in crude oil prices on Monday and Tuesday after steep plunges in recent weeks should provide some relief to many oil producers, not least Saudi Arabia, who are under understandable pressure to prepare a viable strategy of output cuts to put a floor under oil prices through the turn of the year and set the stage for a modest rise in prices – and the Kingdom's oil revenues – next year.

The forthcoming G20 meeting of leading world economies in Argentina at the end of November will provide an indication on whether the bull or bear market traders will decide the next stages of oil price benchmarks, with costly outcome to those who make the wrong bet.

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In simple terms, the key parameters remain oil supply, demand and short-term geo political shocks in that order to determine oil prices. Oil supply, led by US producers, is growing faster than demand and to prevent a build-up of unused fuel such as the one that emerged in 2015, the Organization of the Petroleum Exporting Countries is expected to start trimming output after a meeting on Dec. 6.

That is on the supply side. On the demand side matters have become less certain. A trade war between the world’s two biggest economies and oil consumers, the United States and China, has weighed upon the market.

This is the dilemma that Saudi Arabia, the largest OPEC producer finds itself in and when it has to make some decisions to create some stability in world oil prices. A probable first phase of the Kingdom’s oil strategy will play out at the G20 meeting that starts this Friday.

Iran stands to lose out and has been calling for the abolition of the existing two monitoring committees on the ground that they are dominated by countries that adopt policies against its interests

Dr. Mohamed Ramady

Two-fold objective

And it is notable that Saudi Crown Prince Mohammed bin Salman is going to Buenos Aires and bringing energy minister Khaled al-Falih with him. The objective is twofold: to strike an understanding with Russian President Vladimir Putin on committing Russia to at least token cuts in crude output at the December 6 OPEC-plus meeting, and; from President Trump, a reprieve from threatening tweets on the ground that Saudi Arabia has done its utmost to increase production when called upon in face of outages from Iran, Libya , Venezuela and others and to plan to cut back when prices are hovering at dangerously lower levels that threaten the on-going economic transformation agendas of key oil producers.

The rise and subsequent fall in oil prices this year has been almost entirely driven by production decisions in Saudi Arabia, Russia and the USA and their policies towards managing the impact of renewed sanctions on Iran. According to BP data, the troika accounted for 36 million barrels per day of crude and condensates production in 2017 (39 percent of the global total) compared with just 27 million bpd from the rest of OPEC (30 percent of the global total).

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But there are divergent interests within this troika as production has surged even further this year as US shale firms ramped up output in response to higher prices, while Russia and Saudi Arabia relaxed production curbs put in place at the end of 2016.

With the way cleared at the G20 meeting, a second stage of the Saudi oil strategy will be a credible headline of output cuts at the crucial OPEC meeting in Vienna on December 6 with the Kingdom acutely aware it will have to deliver the bulk of the cuts, and possibly increase the 500,000 bpd in cuts already indicated for December to as much as 750,000 in order to have a more meaningful price impact.

With an additional 250,000 to 350,000 bpd in cuts from Kuwait and the United Arab Emirates, OPEC would be within range of a targeted minimum of 1.2 million bpd in cuts starting in January. Will this be enough to stop the slide in oil prices?

This is where the Kingdom’s undoubted supremacy as the world’s oil central banker comes into play and, in principle, there could be additional potential cuts in output in mind by February or March after they see how oil prices respond to the OPEC cuts and the impact of the Iranian sanctions, any signs of a truce in the US-China trade war spat as well as a better sense of global demand going into the seasonal build up in the second quarter.

The bet, for now is that further cuts that would bring them to or just below the 10 million bpd mark in output may not be needed if prices stabilize by then and even begin a modest rise.

Flexible monitoring

The setting up of a more flexible monitoring committee with a new secretariat in Vienna headed by Russia to recommend production cuts or increases on a consensus basis from January will provide Saudi Arabia with the necessary cover to take action quickly instead of waiting for a unanimous OPEC ministerial decision.

In this new system, the locus of decision-making has shifted from the twice-yearly OPEC conference in Vienna to the periodic meetings of the JMMC and bilateral briefings among ministers.

Iran stands to lose out and has been calling for the abolition of the existing two monitoring committees on the ground that they are dominated by countries that adopt policies against its interests. And are not aboding by OPEC unanimous decisions. The inclusion of Russia as a key energy player with OPEC has been a decisive one.

In this context, it is not surprising that the distinction between OPEC and non-OPEC members has become increasingly blurred and decision-making shifted outside the organization. Discussion and analysis have moved away from OPEC’s twice-yearly ministerial conference to the Joint Ministerial Monitoring Committee (JMMC), which blends OPEC and non-OPEC members.

The JMMC contains two leading non-OPEC producers (Russia and Oman) and just four OPEC countries (Saudi Arabia, Kuwait, Algeria and Venezuela) plus the OPEC president (currently the United Arab Emirates). Iran’s exclusion from membership of the JMMC is symptomatic of its marginalization within OPEC and the wider oil market.

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To all intents and purposes, OPEC has been marginalized as a troika of the United States, Russia and Saudi Arabia takes critical decisions about the oil market. It is a fact of life and other OPEC members have to learn to live with it, as production decisions made in the troika tend to determine whether the oil market will be over- or under-supplied in the short to medium term, while other OPEC and non-OPEC countries watch from the side-lines.

Or simply align their output policies with those of Saudi Arabia. There are exceptions such as Libya and more importantly Iraq, which is planning in increasing its production capacity to 5 million barrels per day – bpd - from just over 4 million bpd and has been able to increase its output significantly in 2017/18.

Can Saudi Arabia make the necessary cuts without harming its fiscal position? The room for the Kingdom’s cuts in output was built into the surge production in November, which some analysts claim reached as much just shy of 11 million bpd in November after having reached 10.72 million bpd in October.

The November surge is unsustainable. But coupled to the shifting market sense of lower oil demand next year -- a forecast shared by the Saudis, which accounts for their reluctance since summer to increase output to the extent they did -- the higher output in October and especially in November, no doubt played a contributing role in pushing crude prices sharply lower.

Another factor was that the Saudi surge was also timed to offset the loss of Iranian crude exports as the US-orchestrated sanctions were expected to further erode Iranian crude exports reaching the market.

President Trump’s sudden reversal to allow so many exemptions to the oil sanctions meant the loss of Iranian crude never materialized, adding to the current oversupply and took both the Kingdom and the Iranians by surprise as the latter seem to thrive under a siege economy mentality.

Dramatic collapse

The dramatic price collapse set off the alarm bells, where the hard realization sank in that they oil producers such as Saudi Arabia would pay in lost revenues and especially lost standing when they abandoned their own hard-negotiated OPEC plus Vienna Framework to increase output under pressure from President Trump.

It will not be smooth sailing as few oil producers are willing to agree to proportioned output cuts, while Moscow, whose participation is considered essential by the Saudis are maybe still unwilling to give Riyadh a commitment to output cuts.

Crown Prince Mohammed bin Salman hopes to change that, at least in terms of verbal support for output cuts, in his meeting with Putin on the side-lines of the G20 meeting.

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The fear remains that a rhetorical support with promised cuts against “future” projected output might not be enough and It is uncertain whether the OPEC cuts, even with the hard barrel cuts by the Kingdom and its Gulf allies, will be enough to stabilize oil prices at a higher sustained range to seek average crude prices around a $70 benchmark for next year.

As the balance of power has shifted away from historically important producers such as Iran, Nigeria and Venezuela, so the focus of decision-making has also flowed into new channels like the new Russian chaired Vienna based Secretariat.

As power shifts to the troika and its closest allies, the semi annual OPEC conference and its OPEC/non-OPEC follow-up committees have become a cosmetic side show rather than where the real decisions are taken, raising some interesting questions on whether there is any life left in OPEC after all.
Dr. Mohamed Ramady is an energy economist and geo political expert on the GCC and former Professor at King Fahd University of Petroleum and Minerals, Dhahran, Saudi Arabia and co author of ‘OPEC in a Post Shale world – where to next ?’. His latest book is on ‘Saudi Aramco 2030: Post IPO challenges’.

Disclaimer: Views expressed by writers in this section are their own and do not reflect Al Arabiya English's point-of-view.
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