Thinking the Unthinkable Part 3: Saudi Arabia is smiling! OPEC 3.0 will force market to listen again!

The next days, media pundits will be looking at Vienna again. The world’s only oil cartel is gathering again for its meeting. No real price developments are expected by the majority of analysts, financial advisors and traders. Main stream analysis is largely focusing on the demise of OPEC as a market mover, the end of the oil cartel is near is the main message. As has been proven in my own analysis “Thinking the Unthinkable (Part 1): "Oil price hike imminent 2016”, https://www.dhirubhai.net/pulse/thinking-unthinkable-part-1-oil-price-hike-imminent-widdershoven?trk=pulse_spock-articles, January 25th 2016, most market analysis is based on wish-full thinking or insider knowledge of speculators. When listening to financials or so-called oil market analysts, prices should have been hitting the $20 per barrel mark already, as market fundamentals (according to Goldman Sachs and others) were showing a tendency of overproduction in the foreseeable future. The facts on the ground were showing another picture, leaving only room for an upward price development, or in case of some additional disturbances a possible price hike even.

After the regional conflict between Saudi Arabia and Iran exploded in the OPEC offices, the long-awaited Doha oil production freeze agreement went up in flames according to the media. Again, analysts were stating that Saudi Arabia overplayed its cards, Iran and Iraq would be flooding the market and price decreases were to be expected. Again, a contrary Dutch point of view, indicating that nothing really changed in the market, Iran’s impact in the global market was overestimated, and Arab oil producers stil were supporting Saudi Deputy Crown Prince Mohamed Bin Salman’s strategy in full, has shown to be right. https://www.dhirubhai.net/pulse/doha-meeting-shows-geopolitical-nature-oil-market-cyril-widdershoven?trk=pulse_spock-articles. OPEC’s strategy to confront the market via market share strategy is still working, prices have increased by over 60% in the last couple of months, hitting the $50 per barrel marker the last days.

Instead of a total meltdown of OPEC, the contrary is currently the case. The internal fighting between leading OPEC members has slightly cooled down. Iranian officials even have indicated that there could be a possible talk between both sides to agree on a possible production freeze. At the same time, news emerged that the oversupply of crude oil on the market is waning. The surplus is even reaching levels which could present possible danger for the overall demand of several developing economies, such as India. Not only is the overall impact of low upstream investments the last years beginning to bite really into production volumes, but increased geopolitical instability in several oil producing regions, such as MENA, West Africa and Latin America, has resulted in major oil production shutdowns. Main proponent of the latter could be a still to be assessed re-emergence of violence and piracy in the Niger Delta region, threatening the total oil production of Africa’s leading oil producer Nigeria. Recent attack on oil pipelines and production facilities in the Niger Delta by militants have brought down overall production by 50% to 1.1 million bpd, in contract to 2.2 million bpd in January.

Iraq’s overall oil production is also being threatened again. This time not by ISIS or Al Qaeda but by a re-emergence of internal Shi’a opposition to the Baghdad government. All time extremist Shi’a opposition leader Muqtadda Al Sadr has declared a war on the Shi’a led government of Prime Minister Haider al-Abadi. If this internal Shi’a conflict is not being solved, a possible implosion of the Iraqi government is to be expected. Destabilisation of the current Iraqi government will not only lead to a full-scale civil war, but also will end the ongoing fight against IS and other Sunni-led opposition groups. Direct impact of the latter will be a possible dramatic decrease of overall oil production in the country, taking into account Al Sadr’s links to the oil producing regions in and around Basra in the south.

Another OPEC producer (and supporter of Iran’s oil strategy) Venezuela is currently seen as the major threat to oil market stability. Analysts are expecting that Venezuela’s overall oil production could be falling to an average of 2.35 million bpd in 2016. At present Venezuela is producing around 2.53 million bpd, according to OPEC and government sources. Ongoing political strife, cash constraints and insufficient maintenance are expected to push production to levels not seen since years. Current figures are also worrying as it is the first ever quarter since 2008 that production fell in all producing regions of the country, including the extra-heavy crude Orinoco Belt. A total meltdown is possible if the political conflict with president Maduro continues or even erupts on the streets.

The pressure on Saudi Arabia’s unofficial leader Deputy Crown Prince MBS has decreased substantially, even more than media sources have been portraying the last weeks. The Saudi strategist has been able not only to proceed with his overall oil market strategy, despite high pressure from fellow OPEC countries, Russia and others, but also was capable of shaping the future of his own country’s oil sector dramatically. By removing all time Saudi Minister of Oil Ali Al Naimi from power, MBS was able to put in place Khalid al Falih, former Saudi Aramco CEO, as the new face of Saudi’s OPEC strategy. Al Falih is more than capable to address worries in the market and take other OPEC producers by the hand to confront the challenges in front of them.

Nobody expects that OPEC will be able to come to a new agreement, as some are hoping. No production freezes or cuts will be stated, the market is enough already in balance to produce the impetus to increase prices even more. Some expect that there could be a concensus reached on production freezes, but in the light of Iran and Iraq’s overall objections this will most probably not even come on the table.

The market share strategy, put in place by kingpin Saudi Arabia, has shown to be the most applicable. The effects have been as expected, even that the period that it needed to get there was longer than expected, some Saudi analysts admit. Still, Saudi Arabia, supported by its Arab neighbors, has been able to quell the growing surplus of non-OPEC crude oil production, bringing American-West European oil production to the abyss, while hitting others, especially Russia, Iran and Venezuela, hard where it really hurts, in their pockets. Most non-OPEC production regions are currently fighting for survival, while anti-Saudi forces Iran, Venezuela and Iraq, have been kicked into the corner. Even that Saudi Arabia’s public finances have been hit hard, Riyadh’s approach now looks to be bearing fruit.

In stark contrast to the last couple of years, OPEC’s oil market share strategy is also receiving another major support boost, this time from its former adversaries, the hedgefunds and institutional investors. Since the beginning of 2016, around $5 billion has coursed into these funds, showing the largest increase of inflows since 2009. There is an obvious increase of financials going long on crude oil, which has not been seen since years too. All traffic signs seem to be heading to be green, even Bull Market culprit Goldman Sachs is now indicating that prices have bottomed, leaving large opportunities for price increases. The latter developments have already been part of the current price rally in crude oil markets. The attraction of making money again by speculating on higher oil prices has been attracting more and more managers lately.

Between 2012 and 2014 commodity money managers were starved of capital, as total outflows are set during that period of around $6.2 billion. The attractiveness of commodities is also reported by a March 2016 report of eVestment, based on 290 commodities-focused hedge funds. The latter showed that the funds have managed $70.5 billion at the end of March, rebounding from a near six-year low of $65.4 billion at the end of last year. Returns on average first four months in 2016 are set at 6%, while showing a loss of 10.4% in 2015.

The coming weeks, Riyadh’s strategy will fall totally in its place. The latter market share’s strategy is showing an impact, expected by some, but doubted by most, which is bringing blood on the wall for most non-OPEC producers and even some OPEC hard-liners (Iran, Venezuela). As both main oil benchmarks, West Texas Intermediate (WTI) and Brent crude, are showing an upward trend, after briefly touching the psychologically important level of $50 a barrel, Arab producers are starting to smile. Since the beginning of 2016 double figure US shale oil firms have gone bankrupt. Non-OPEC production is dropping sharply, even expected to show very red figures the coming months to come. Conservative energy think tank IEA even has stated that global oversupply would "shrink dramatically" (May 12, 2016).

For Saudi Arabia, and its GCC compatriots UAE, Kuwait, Bahrain and Qatar, the picture becomes rosy again. Based on production cost figures, they all are above the redline, while government budgets have been cut (politically the right time, as most Arab regimes could claim financial difficulties). Still, OPEC’s overall strategy is still in doubt. Saudi-Iran confrontation continues, or is even expected to increase further, due to fighting in Syria, Yemen and Iraq. The fact that Iranians are not able to go this year for Hadj (Mekka) is a sign that the conflict between Tehran and Riyadh is heating up. Possible OPEC instability could be the case the coming months, but people should not overestimate the impact of Iranian-Iraqi production increases in the overall picture. Saudi Arabia, as the largest producer in the oil cartel, backed by all other GCC Arab producers, will be able to put pressure on any Iranian-Iraqi strategy to flood the market. Riyadh has indicated that it will be pushing for production increase capabilities, leaving no room for any other non-Arab country to take an advantage of market share openings due to failure of non-OPEC producers. Saudi Deputy Crown Prince MBS has openly indicated that the floods from hell will be opened (Saudi additional production increase) if Iran and Iraq are not willing to comply. This is more than possible at a price of $50 per barrel, and struggling non-OPEC production. The time schedule of the Saudi strategy has been perfect. Prices are up, profits are up for Saudi and GCC producers, leaving enough room to block additional Iranian production if needed. Some increased volatility can be expected, but taking all factors into account, room for price increases is there for sure.

One specific issue is still to be assessed. Libya’s current instability, the expected military action against IS/Daesh in Libya by Western or Arab forces in the coming months, will most probably take out another million bpd for the middle- or long term. The latter will result in a price hike, as oversupply is almost gone.
As stated in January 2016, the oil sector is heading for a renewed price hike. Investments have been hitting historical low levels (except in Arab OPEC countries!). The fact that investments by IOCs and Independents are still being deferred, increases the upward tendency for price hikes the coming months and years.

If no real implosion occurs in Vienna, OPEC’s leader Saudi Arabia will be openly smiling in front of the cameras. Based on current predictions, crude oil prices could be heading even to $70 per barrel, if instability in the producing regions increases. All will depend on the support of Arab producers (and unofficially Russia) for Saudi’s market share approach. No room is currently left for non-OPEC or Iran to block these adventures. MBS has been playing a very hard Chess Game, but his current approach leaves him almost looking at an enemy confronted with a Check Mate situation. OPEC’s demise is not going to be the case at all. OPEC 3.0 is in the making, the specifics will become clear in the coming months. The oil cartel has again been able to sail through stormy waters, but has a new young captain (MBS) and a very capable crew to handle possible Iranian or non-OPEC storms.