OPEC and OIL

OPEC meeting of 27^th November, 2014 will be remembered for long for bringing down the oil prices by more than 30% in less than a month in a depressed market and threatening world economy.

The OPEC decision in the aforesaid meeting was apparently taken with a single point agenda to maintain OPEC supremacy and Saudi Arabia’s dominant position in Oil. It is not very clear why Saudi Arabia adopted an unconventional approach.

The probable factors are:

(a)    Threat to the dominant position of Saudi Arabia due to increased production of Shale oil in North America.

(b)   Reluctance of Non OPEC producers (Russia/Mexico) to cut production.

Saudi Arabia and some other  OPEC members believe that the market will settle at appropriate level as producers with higher cost of production will go out of the market—a clear pointer towards Shale and some Non-OPEC producers. It will certainly happen at some point of time as otherwise there will be glut as storage is not unlimited, but may take place after causing considerable damage to the economy of major oil producing nations and to the world economy.

Initially, major oil exporting countries—OPEC or NON-OPEC are going to be worst affected and Oil consuming countries will benefit. However, if the market does not stabiles at $65-75/bbl by February, 2015, it could affect even oil consuming nations due to onslaught of recession in the world economy. This may sound bit paradoxical as not long ago, high oil prices were considered to be detrimental to the world economy. The change in the scenario is due to huge investment in the Oil and Gas sector world over during last decade due to high oil prices after 9/11 leading to tension in the Middle East. If oil prices now go down to unsustainable level, it would result in underutilization of  capacity in the oil and gas sector and even abandoning  investments in projects at various stage of implementation/planning. It means huge unemployment, not only in oil producing nations but also in other countries as capacities/ investment in oil service facilities and equipments will also idle. The impact will also be seen in major OPEC countries including Saudi Arabia, but may be only after a year or so and if oil prices go below$50 per barrel. It is learnt that the Saudi Arabia has planned its 2015 budget at current oil prices i.e. $60 per barrel.

There are 3 major players in this Oil market— Shale Oil producers in North America, Non-OPEC producers (Russia/Mexico) and OPEC.

Let us examine possible scenarios:

Who will blink first?

Will some Shale producers in US cut production?

Most Likely. Some of the shale producers are already planning cut in production, especially those having production cost of $70+/bbl such as Bakken Shale in North Dakota, Permian Basin in Texas etc. As such USA is a great beneficiary of falling oil prices as she is still importing about 7 million barrels oil per day, but the stress in the economy due to unemployment in the oil sector and abandoning of various oil projects including exploration activities in Alaska may jeopardy the US economy, if sub $ 60/bbl prices continue for extended period i.e. second half of 2015

Will Non OPEC (Russia/Mexico) cut production?

The possibility is quite high. It is almost impossible for Russia to survive, if oil prices fall further. Russia needs higher revenue. It is also perceived from market sources that the real issue with OPEC is not Shale producers but Non OPEC producers like Russia. The decision of the OPEC in the 27^th November meeting could have been quite different had Russia agreed to share the cut in the production.

The grey area is the cold war between OPEC and Non-OPEC. Will logic work and better sense prevail?

Will OPEC Cut Production?

Some OPEC members have the capacity to withstand the financial onslaught of falling Oil Prices for considerable time while some others desperately need higher prices. Unless Saudi Arabia agrees to cut production, there is no possibility of cut by OPEC as the impact of cut by other producers will not have any meaning full impact besides inviting the wrath of influential members.

In all probability, the cut in Oil production could come sooner than later and certainly not later than  March, 2015 due to limited oil storage. OPEC cannot afford gradual fall in prices as continued downward trend in prices prompts the consumers to defer import to gain advantage of lower prices, and gives time to the other producers to develop alternative strategies to withstand the adverse impact on economy. OPEC would make all efforts to ensure that the production cut is done by Non –OPEC producers  at the earliest to go back to the Oil prices of $70/75+.

The steep fall in oil prices  during last one month was not only due to the decision of OPEC in November meeting but further escalated by the enhancement of discounts on market linked formula prices by Saudi Aramco for its worldwide customers in the first week of December for supplies in January. This led to similar reduction by other Gulf producers.  This was a master stroke and well thought strategy by Saudi Arabia.

Saudi Aramco is to declare discounts for February supplies on 1^st of January. These discounts will give clear signal of the forward path of Saudi Arabia.

In our best assessment, it is very likely that the Discounts will be further enhanced for February supplies to give knee jerk to the Market. Wait and watch!