In its meeting over the weekend, OPEC dismissed Donald Trump’s insistence that the organization increase oil production. Just about everybody in my network expected the rebuff. Any official decision to change OPEC production levels would have required ministerial approval and the weekend meeting in Algiers was not such a meeting.
What did emerge, however, was a growing frustration among my OPEC contacts. Already, as one noted via telephone to me yesterday, “we have regularly ignored his petulance,” he said, adding, “but this latest round of bluster borders on an attempt to insert [American] domestic politics into OPEC internal policy.”
That view is widely shared. Many in the Persian Gulf – even among my colleagues in nations more amenable to US interests – regard the reason for Trump’s problem as largely self-inflicted.
While the global oil balance between production and demand has been narrowing for some time, a White House decision to initiate a tariff war combined with the unilateral re-imposition of sanctions against Iran have certainly exacerbated the situation. The result has been significant upward pressures on price.
Here’s where the politics come in. Moving into a critical off-year election, concerns emerge over rising oil prices translating into increasing consumer costs for refined oil products. A sensitive political mantra renews: “Gasoline votes.”
Trump’s Iran Sanctions Worsening Supply Picture
To understand the corner Trump has painted himself into, consider the current state of the global oil market.
Because of problems in only three of its member countries – Venezuela, Libya, and Nigeria – OPEC is anticipating an export loss of an additional 1.9 million barrels a day (mbd) before the onset of renewed Iranian sanctions.
Venezuelan state oil company PDVSA has been in dire straits for much of the past two years. In that time, production has declined to less than 1.2 mbo/d. That’s less than a third of what the figure had been two years ago. At current projections, this could fall further to less than 1 mbo/d by the end of the year.
Venezuela has been forced to sell oil assets at bargain basement prices just to avoid a financial implosion. This has led to China and Russia coming to control entire sectors of both national oil production and central government finance.
Libya meanwhile has a drain of about 850,000 bo/d due to ongoing civil unrest, with virtually all of that deducted from exports. Essential port infrastructure is not secure with competing factions impeding the flow of oil from what fields are still reliably producing. And Nigeria, while having managed to level off its decline curve, is looking at lower production than last year in the face of a significant cut in available capital investment.
All of this is unfolding before the Iranian sanctions kick in. The US renewal of those sanctions is set to hit on November 4 and will further accentuate the supply side pressure. Iranian exports should average 1.8 mbo/d this month, down from 2.3 mbo/d in July. I am now estimating that figure could be as low as 900,000 bo/d in November, a net loss of 1.4 mbo/d in less than three months.
That puts the combined export decline from Venezuela, Libya, Nigeria, and Iran alone at 3.3 mbo/d before the end of this year.
Russia Nearly Maxed Out
Yet the most overlooked factor in all of this involves reliable additional production to make up the difference. OPEC excess capacity statistics are misleading. The organization has only about 2.8 mbd of additional production that can be consistently injected into the market, more than 60% of that Saudi.
Of course, there are other non-OPEC sources. The Paris-based International Energy Agency (IEA) estimates a 2 mbd production increase from non-OPEC nations for all of 2018, but that potential is also set to decline next year.
The bulk comes from two countries – Russia and the US.
Russia is now producing at post-Soviet highs but has essentially reached a ceiling that cannot be sustained much beyond current levels. Most of that production is coming from mature Western Siberian fields where aggressive drilling has brought questions of reserve integrity into the conversation.
Without an influx of new volume from new areas, the traditional base of Russian production is seen as contracting with an annual decline of over 8% taking place early next decade. To offset this, Moscow must move in four directions: above the Arctic Circle, out onto the continental shelf, into Eastern Siberia, and deeper below present production.
All are very capital intensive and require access to specialized technology and expertise. All of these have been made more difficult by existing foreign sanctions (once again led by the US) directed against Russia.
Eastern Siberia has considerable extractable oil and natural gas but also a huge price tag arising from a total lack of infrastructure. Additionally, the resource existing below the heavily developed Western Siberian basin is heavy oil for which Russian companies do not have the technological ability to exploit without Western help.
Steam assisted drilling approaches, most often used elsewhere, merely collapse the frozen tundra when applied to Russia.
Tighter Market Puts $100 Oil On Horizon
Meanwhile, US production continues to expand into record territory approaching 11 mbo/d, on track to replace Russia as the largest worldwide producer by 2020. There are considerable (and readily available) surplus American reserves that could offset declines elsewhere in the world.
OK, then why hasn’t Trump extolled the virtues of US production to offset the global price rise? Why has he decided to put pressure on the Saudis instead?
For a combination of reasons all arising from the structure of the American production sector. First, much of the additional production would come from places like the prolific Permian Basin in West Texas and Eastern New Mexico. Unfortunately, bottlenecks in pipeline and transport networks are already leading to midstream gluts that would be accentuated by ramping up further production.
Second, the oil supply concerns are global not domestic. Additional US production would need to be exported. But any dramatic expansion of export volumes over the present levels maxing out at around 3.2 mbd is not possible given port, delivery, and infrastructure capacity limitations. There are plans to address this, centering on expanding in places like Corpus Christi down coast from over-extended Houston and its shipping channel, but those plans are not going to have a major impact for some time.
Third, that would result in a rapid expansion of oil volume in the domestic market, leading to lower prices and lower profits, exactly counterproductive to the expectations of what has been a strong Trump political base.
So, jawboning the Saudis is Trump’s only option. That such an approach has been rejected by OPEC with the support of Russia indicates that the price problem will intensify.
This is not to say there is a global oil shortage. On the other hand, it does indicate a constriction in the supply- demand balance is forming rapidly. Crude prices will be going up and moving downstream to higher prices in oil products.
This is a very fluid situation. But my current estimate is for Brent to be over $90 a barrel before the end of the year. Should present conditions continue, that benchmark could be approaching $100 by the end of the first quarter 2019.