Saudis won’t add more barrels, but will step up when needed

The most important thing to emerge from the Opec meeting 10 days ago is that Saudi Arabia will not force more oil into the market while Iran restores its exports to the level before the nuclear sanctions. The supportive Saudi stance was confirmed last week when Riyadh raised its pricing formulas rather than engage in another round of competitive price discounting, which took Brent down to US$27 per barrel early this year.

This does not mean the country is returning to its long-maintained role as Opec swing producer. For the moment, it will tacitly freeze production while a series of supply disruptions work themselves out.

Down the road, it will seek higher exports as high-cost producers lose increasing amounts of capacity to production decline and bankruptcy as the world oil market – with no assistance from Riyadh – rebalances itself.

With oil prices half the level of two years ago and a money-primed world economy expanding more than expected, oil demand figures are now being revised up once again and the global increase may end up being 1.5 million bpd this year.

Surprisingly, the Saudi energy minister, Khalid Al Falih, even predicted perhaps an extra 200,000 to 300,000 barrels per day of the trending increase in demand eventually going to shale producers. But shorter-term, at $50 per barrel he did not predict shale raising its head for another battering of the sort it invited when prices above $100 were drawing forth annual additions to capacity of nearly 1 million bpd.

There have been reports of US unconventional producers starting to frack suspended wells, and the US rig count has very recently been rising (from a very low level). Yet there is a wide range of costs in the US shale window, and although the Permian Basin may continue to expand production, most other shales are dead in the water at current prices.

American banks will not be as cavalier in their lending to shale operators as they were at levels over $100 per barrel, and the warnings of the US Federal Reserve over the impairment of financial balance sheets mean the flow of funds to the energy sector will continue to contract dramatically.

So will it be worldwide, and just as it has taken two years to turn the juggernaut of high-cost production to decline, it will require many years before the more expensive sources of petroleum expand again, if ever.

Arabian Gulf producers will step in whenever expanding demand requires more barrels, and Russia with its new rouble-devalued cost structure, will participate to a lesser extent in output growth.

The structure of the market is returning to backwardation, with the spot Brent price rising above Brent futures on Friday. This reflects the gradual return of 1.2 million bpd of Canadian oil sands production to North American supply, now that the wildfires are being brought under control.

The backwardation also reflects a tightness in physical barrels as the world’s refineries move into high gear for the summer driving season. If there are other supply disruptions, such as the loss of a third of Nigerian production to sabotage, prices may mount to $60 or even $70 per barrel if traders panic.

The only thing that could now overcome the additional barrels from Iran and Iraq would be civil strife in a major producing country. The economic chaos in Venezuela might generate a wave of strikes, but the army is supporting the Maduro administration.

If there were further disruptions, Saudi Arabia would take the opportunity to increase its exports at current prices. The world is swinging around to the Saudi and UAE view that the future of oil will revert to the low-cost producers.

Jim Crawford is the managing director at the Sharjah-based Inter Emirates General Trading Company.

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