Can Saudi Arabia Hold OPEC Together?

November 8, 2019/

The descent of choking smog on New Delhi in the last week cannot help but refocus India’s political attention on the contribution of coal-fired plants and roadside emissions to urban air pollution, even if nearly half of the recent incident was attributed to stubble burning from farmers by the country’s Supreme Court.

Whether the immediate impact of air pollution in China or longer-term concerns over climate change have been the biggest driver of Chinese environmental policy is a point of debate, but the combination has certainly been powerful. India now has a reminder that it needs to actually deliver on its ambitious renewable energy targets and plans for alternative transport.

The likely impacts will be to bear down on coal-fired power and redouble efforts to electrify and gasify transport and city energy use more broadly – in other words air pollution is positive for renewables and LNG demand but negative for coal and oil.

For a country expected soon to become the most populous in the world, and one which should benefit economically from its demographic dividend of young workers, India’s energy and environmental policies will become an increasingly important factor in global energy commodity demand, just as China’s have been over the last decade.

Upside oil factors

In the short term, positive news flow on the trade front is supporting oil prices as China and the US inch towards a phase one trade deal. This looks likely to at least avoid the imposition of new US tariffs on Chinese goods and potentially reduce those already in place, but it will not return the global trading system to the pre-trade war environment.

Tariffs on billions of dollars of goods are likely to remain as Washington will want to retain leverage going into phase 2, which will deal with the much more difficult issues of Chinese industrial subsidies and the forced transfer of technology.

There is unlikely to be a return to rules-based trade dispute resolution, at least not while US Donald Trump remains in power. And the damage inflicted on global trade cannot be reversed although it can be recovered from. The persistence of substantial tariffs into phase 2 of the talks will drag on this recovery, which has yet to get underway. But, for the moment, sentiment at least sees recovery on the horizon rather than a further slowing of global economic growth.

Iraq unrest

Major unrest, social protests and increasingly severe responses to public demonstrations have re-ignited concern over the stability of Iraq, which has become not only OPEC’s second-largest oil producer but one with the most significant long-term production growth prospects. The government’s solution to the disturbances, a general election under a proposed new electoral law, will be difficult to construct to all parties’ satisfaction.

The governing elite’s lack of social license, the country’s sectarian divisions and the potential for a re-established ISIS presence in northern Iraq are long-term sources of instability.

Changes to the political system are also likely to have implications for relations between the Kurdish Regional Government and the federal government in Baghdad, potentially affecting northern crude oil exports.

Although total oil exports appear unaffected for the moment, Iraq’s unstable political situation remains an upside risk to oil prices. Political paralysis will make delivery of the large-scale infrastructure projects necessary to take oil production beyond its current levels even slower.

Saudi IPO

It is in this environment that Saudi Arabia announced its plans to go ahead with the sale of a portion of Saudi Aramco shares on the Saudi stock exchange, the Tadawul, next month. Shares will be offered to invited investors and on the main market, with the price, volume and timing to be determined by a book-building period.

Opting for the Tadawul rather than London or New York will limit accessibility, but allows Saudi Aramco to act more quickly. Although Initial Public Offering plans have been long in gestation, the timing of the move might be taken as a signal that 2020, at least the first half, is unlikely to prove a strong period for oil and it is better to act early before pricing conditions deteriorate.

Given the timing of OPEC’s next meeting on December 5-6, Riyadh has an interest in talking up a firm OPEC output policy as the book building proceeds and the IPO takes place.

Given also the likely rise in non-OPEC oil production expected next year from a diverse set of countries extending beyond the US shale sector, Riyadh appears to be grasping at a fleeting window of opportunity to monetize its oil reserves through a share sale rather than production.

OPEC’s big decision

The wider conditions surrounding OPEC’s position do not look overly positive. The organization functions best in an environment of strong oil demand growth in which non-OPEC production is static or declining. Neither of these conditions currently prevail.

Oil demand growth is weak both in the short term, as a result of slow trade growth stemming from the US-China trade war, and longer-term as a result of the growth of alternative modes of transport. While OPEC glumly mulls oil demand growth of about 1 million b/d this year, it is worth remembering that in its 2018 World Energy Outlook, the International Energy Agency predicted oil demand would grow by just 0.25 million b/d a year on average post-2025.

While OPEC-plus controls a huge share of the oil market, it is not the size of the remainder that matters so much as its dynamism, and US shale is unquestionably dynamic. Moreover, it is not the only source of activity as evidenced by the success of Brazil’s 16th bidding round, even if the prospects for Argentinian shale appear to have suffered a serious reversal as a result of a Peronist government being elected in Buenos Aires.

Moreover, while the OPEC-plus group may have extended OPEC’s reach hugely from a market share of 41.5% to 60.8%, based on 2018 data, it also brings a more unstable coalition of producers with more internal competing interests. A downside of the creation of OPEC-plus is the fall out if OPEC proves unable to carry the OPEC-plus group with it, whatever decision OPEC itself reaches

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