Oil exporters brace themselves for a global trade war

Petroleum Monitor Executive Summary

Published by Peter Kaznacheev, Khaznah Strategies Ltd., 28 June 2018

At the OPEC summit last Friday, oil ministers settled to increase output by a preliminary 1 million barrels per day — a decision which helped to soothe the market. This indicates that Russia and Saudi Arabia are willing to abandon their previous strategy of boosting oil prices by suppressing production. But there is a bigger problem on the horizon — the looming global trade war.

Muhammad bin Salman and Vladimir Putin agree policy shift during World Cup

·      Back in December, OPEC+ (the agreement to cut production between OPEC, Russia and nine other exporting countries) extended the 1.8 million barrels per day cuts until the end of 2018.

·      Countries in the OPEC+ agreement reported exceeding their targets by more than 50 percent, largely due to the near collapse of Venezuela’s petroleum industry. 

·      However, after Saudi crown prince Muhammad bin Salman met with Vladimir Putin at the World Cup tournament, both Saudi and Russian officials suddenly demanded a relaxation of the quotas. There is a reason for such a policy shift.

Economic considerations prevail in the Saudi-Russian alliance

·      In terms of oil diplomacy, the Russian-Saudi alliance has been a success. Nonetheless, it testifies not to the strength, but to the weakness of OPEC.

·      In the past, the Saudis managed to balance the oil market without the assistance of Russia. But then the shale revolution shifted the role of “swing producer” from the Saudi monarchy to the United States.

·      Back in 2016, when the price of a barrel was dangerously teetering near the $30 mark, politicians in Saudi Arabia and Russia were ready to do everything to rectify the situation.

·      The long-term economic consequences of implementing the quotas were not the main priority. But as the oil price panic receded, the two countries could weigh the pros and cons of their actions.

Oil production quotas are a double edged sword

·      From the very beginning, production cuts had a risk attached to them. By cutting back output the OPEC+ oil exporters were creating a vacant market niche, which was then filled by producers outside of the agreement, including U.S. companies.

·      As a result, in 2018 the United States surpassed Saudi Arabia in oil output and is now on course to overtake Russia and become the largest producer in the world.

·      Consequently, neither Saudi Arabia or Russia is willing to continue giving a boost to American producers. Long-term economic considerations have prevailed over politics — and this is a very significant result of last week’s OPEC meeting in Vienna.

There is a larger problem looming over oil producers

·      At the OPEC seminar in Vienna many industry leaders expressed their fears about the spreading trade conflict. The CEO of Total Patrick Pouyanne captured the mood: "Trade wars are bad news for the world economy". Unfortunately, the energy sector is no exception.

·      After Donald Trump introduced tariffs against Chinese goods worth $50 billion, China responded with trade restrictions of the same magnitude.

·      Trump in return upped the ante and threatened China with a new series of tariffs — this time affecting goods worth up to $400 billion.

·      By definition, there are no winners in trade wars. For example, U.S. tariffs on Chinese steel are hurting American pipe manufacturers and oil services companies. And their losses will eventually be passed on to the end petroleum consumer.

Exporters are targeted by Trump’s NOPEC bill

·      The trade conflict could spread beyond U.S., China, EU and Mexico. Trump submitted a bill that would make it illegal for any international organisations (i. e. OPEC) to restrict oil production. Tellingly, it is dubbed the No Oil Producing and Exporting Cartels Act, or NOPEC.

·      If the bill is approved (and Congress has already given it preliminary support), OPEC countries could be subject to the Sherman Antitrust Act.

·      In the early twentieth century this Act was the legal basis for dismantling John Rockefeller’s Standard Oil.  

A global trade war is a major risk to oil demand growth and economic stability

·      Some OPEC countries could gain from China’s tariffs on U.S. crude shipments. They could replace U.S. export volumes which stand at just 300 thousand barrels a day.

·      However, these temporary gains could be dwarfed by losses due to a potential reversal in global oil demand growth, which is extremely sensitive to world GDP dynamics.

·      The International Energy Agency recently forecasted this year’s increase in global demand at a healthy 1.4 million barrels per day; and a similar one for next year.

·      This prediction came with an important warning: the main risk factor which could reverse this trend is a rapid deterioration of global trade.

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