By Arab News
By Cornelia Meyer*
Oil prices slumped on the Monday after President Putin’s re-election when Russian Energy Minister Alexander Novak announced that he considered the agreement between OPEC and 10 non-OPEC countries to have run its course when markets reached balance.
The deal has taken 1.8 million barrels per day (bpd) out of international oil markets since January 2017. Saudi Energy Minister Khalid Al-Falih put things in perspective toward the end of the week when he reiterated his preference for markets to be on the tight side. He also said that the agreement would run through 2018 and that he was investigating future frameworks for cooperation.
Prices started to rally earlier though, because the Energy Information Administration’s numbers showed a 2.8 million barrel withdrawal from US crude inventories and a whopping 580,000 barrel decrease in US crude imports, a sign of changing trade patterns as US shale production ramps up.
Donald Trump’s firing of his National Security Adviser H.R. McMaster and replacement with John Bolton sent jitters through the markets because Bolton is a hard-liner on Iran. Observers fear that a US withdrawal from the Iran nuclear deal could potentially take as many as 1 million bpd out of the market. The last week saw oil prices rally to $70 per barrel, the highest since January 2018.
We see these swings precisely because markets are getting tighter. At the same time markets and trade flows are realigning, as increased US shale production is entering international markets. As the US is set to become the world’s top oil producer toward the end of the year, the question will be where these incremental shale barrels will find their markets.
The first shale revolution redirected trade flows away from the US to Asia. In particular, African crudes no longer crossed the Atlantic but searched for a home in China, India and so on. When oil prices bottomed during 2015, US shale production went into a hiatus.
Since then, the shale space has become leaner and meaner and can now easily produce at a profit as long as the price does not go below $40 per barrel, which is in part what explains its explosive production growth over the past 12 months. By now legislation is also allowing for US crude to be exported. Whereas this gives every incremental shale barrel more options, it may not always be so easy to accommodate the quality.
Shale oil is lighter than other crudes and refineries are largely configured to accommodate a heavier and sourer quality of crude. This means that many US shale barrels will criss-cross the globe to find a refining home. For instance, when the first cargo of crude reached the UAE last December, it was not so much an achievement of US oil exports but rather a sign that it was hard to place these incremental shale barrels.
In other words, these barrels will slosh around the world in search of an opportunity to be processed. The harder it gets to find that home, the more they will be traded at a discount. (As long as the price is between $60 and $70 per barrel, costs can easily be covered.) Refiners will try to find balanced supplies, which accounts for instance, for the African cargoes now going back to the US to make up for lost imports from Venezuela.
As long as demand is growing all barrels will find their refining home, but some qualities of crude will be traded at a relative premium and others at a discount.
For the GCC producers, Saudi Arabia in particular, the OPEC/non-OPEC production cuts have come at a cost. Saudi Arabia has lost out to Russia as the biggest crude importer to China and surrendered that position in India to Iraq. KSA in particular will have to observe how the incremental shale barrels will affect its exports.
We should take a more differentiated approach when looking at ever-growing shale production and take into consideration trade flows, because they matter in terms of supply strength as well as in terms of relative price levels. Expect those battles to be fought out in the hotly contested Indian and Chinese markets, which account for at least 50 percent of demand growth over the years ahead.
- Cornelia Meyer is a business consultant, macroeconomist and energy expert. Twitter: @MeyerResources