OPEC (Organization of the Petroleum Exporting Countries)

It’s a geopolitical jungle out there in the oil world right now and only the fittest will survive. The new oil Darwinism is replacing the older thesis that all producers can succeed over time because the current lack of adequate capital investment is going to create an oil supply gap in the future that will once again boost oil prices (the so-called supply hole thesis). There are still some active looming supply crunch proponents who are talking down the potential of U.S. unconventional oil and gas, but recent announcements by ExxonMobil and Chevron about robust plans for U.S. onshore drilling appear to dispel the notion that a debt-ridden U.S. industry is on the verge of potential failure. Projected Permian oil production for the two American oil majors alone is 1.9 million barrels a day by 2024, on top of already robust output from U.S. independent oil companies. Citi estimates that U.S. oil production increases could fill most of the expected increase in oil demand for the next five years. That could leave OPEC in a bind, Citi suggests, since the producer group could lose up to three million b/d of market share to U.S. producers if it chooses to cut production to defend $65 oil prices, according to Citi estimates. The unexpected success of U.S. shale has - for the time being - been ameliorated by the dramatic demise of output from within OPEC’s ranks. A variety of ongoing problems from civil unrest to sector mismanagement have created supply disruptions from Nigeria, Libya, Algeria, Venezuela, and Iran, the latter two impacted additionally most recently by U.S. sanctions policy. The situation prompted one Middle East oil leader to note privately that OPEC’s stronger members will take market share from smaller, more troubled OPEC members whose sectors are continuing to stumble. In the past, OPEC’s largest producers Saudi Arabia, the United Arab Emirates, and Kuwait have stepped in to replace fellow OPEC member oil exports disrupted by sanctions or war. The process has often created acrimony inside the producer group, especially when new production sharing agreements are required when and if a disrupted producer’s oil output is restored. This time around is no different. Iran, whose oil exports have recently been curtailed by U.S. sanctions, threatened to quit the organization at OPEC’s end of year meeting last December in Vienna amid accusations that Saudi Arabia and Russia were taking advantage of its conflict with the United States. A last minute compromise, orchestrated by Russian energy minister Alexander Novak, salvaged the tense situation by promoting a compromise, which exempted Iran from the wider OPEC-Russian production cut agreement. In the longer run, cohesion might become more difficult for the current OPEC grouping as divisions arise between members whose industries are deteriorating and need sharply higher prices to offset declines and those who can cope with new competitive forces and still be able to expand. For the time being, OPEC’s larger members are trying to preserve the organization while at the same time, embarking on strategies to cope with future challenges. Abu Dhabi’s national oil company (ADNOC) is partnering with Western firms to apply new technologies to boost capacity to five million b/d by 2030 and is looking for refining assets abroad. Saudi Aramco is pursuing a sophisticated strategy that includes diversification into natural gas, petrochemicals and trading as well as making sure to keep its production costs low to extract as much revenue as possible from legacy assets. But beyond diversification strategies, officials from OPEC’s big guns - Saudi Arabia, Kuwait, UAE and Iraq - have such low cost production that they are assuming that they can be the last ones standing. But while it might be tempting among Middle East producers to forge a policy to wait for U.S. shale to peak and sputter out in the coming years, it is early days on drilling technology innovation with new ideas on how to tap improved data, automation, lasers and CO2 injection to improve recovery rates not only in the United States, but around the globe. All that technology might mean that pure geology (e.g. ultimate size of reserves) might not matter as much as stable access to capital as a new winning characteristic of the future Darwinian challenge in oil. Thus, in the new Darwinian oil world, we can expect to see continued announcements about how low the largest players can go on costs. ExxonMobil threw down the gauntlet recently by stating its next Texas Permian oil increment will come at price tag of $15 a barrel, substantially below break evens for some of the smaller U.S. companies operating in the Texas shale. It’s also well below the kind of oil prices needed for OPEC’s member fiscal budgets which require oil prices to range from at least $45 to as high as $80 a barrel, depending on the country. As a new report published by Council on Foreign Relations on the Tech Enabled Energy Future notes, the convergence of automation, artificial intelligence, advanced manufacturing and big data analytics is poised to remake the transportation, electricity, and manufacturing sectors in ways that could eliminate oil use just at the same moment when those same technologies could make it easier and cheaper to extract oil and gas. As digital energy technologies take hold, large oil producers will have to consider whether their reserves could depreciate in value over time if they delay oil production and development in an effort to hold up prices in the present and garner short-term revenues. This reality is adding to the challenges many oil producer governments already face from mounting budgetary stress, prompting widespread calls for energy sector reforms in a host of oil states around the world. In the new digital energy world, fittest is being redefined and access to the largest reserve base will no longer be the overwhelming metric for success. The winners and losers could prove surprising.

Congress is considering a bill that could punish countries for artificially boosting oil prices. What could that mean for warming ties between Russia and Saudi Arabia?

The Organization of Petroleum Exporting Countries (OPEC) decision to cut oil production by 1.2 million barrels a day (b/d), together with Russia and a few other non-OPEC producers, may have garnered the organization’s members a few extra dollars temporarily, but it belies larger problems ahead for the 57 year old cartel. OPEC has weathered many geopolitical and economic challenges in the past, not the least of which was surviving land wars between countries in its membership and multiple crashes of oil prices below $10 a barrel. But, like many things changing in the current world order, OPEC’s mission is starting to look increasingly anachronistic and events swirling around the meeting last week in Vienna foreshadow conditions that might require more introspection than the organization or its members will be able to muster. The United States’ response to OPEC may also seem effective in staving a rise in oil prices this autumn, but Washington also needs to give further examination to its long run strategy regarding the cartel. Two of the big side disruptions at OPEC’s latest December gathering was the appearance of Brian Hook, Special Representative for Iran and Senior Policy Advisor to the Secretary of State at the U.S. Department of State, at the sidelines of the meeting and Qatar’s surprise announcement it would be quitting the organization. Mr. Hook confirmed to reporters just ahead of the OPEC meeting that the U.S. had to grant waivers to Iranian oil sanctions “to ensure we did not increase the price of oil.” The envoy said ahead of the OPEC meeting that he expected a “much better-supplied oil market” in 2019, when he said the U.S. would be in a “better position to accelerate the path to zero [Iranian Oil Exports].” The role of the United States in choosing the pace at which to eliminate Iranian oil from the market explicitly based on oil prices raises all kinds of thorny problems both for OPEC and for U.S. policy makers.  U.S. sanctions on Iran and any waivers were clearly a factor OPEC has had to consider in forecasting global oil market supply, but the appearance of Mr. Hook at the sidelines of the OPEC meeting in Vienna last week was problematical because it implied, perhaps accidentally, a level of coordination that goes beyond just jawboning allied oil producers to put out more oil to replace Iranian barrels. The controversy surrounding Mr. Hook’s visit to Vienna calls attention to the age-old question that has plagued OPEC in recent years: what oil price should be considered too high or too low? One might have thought that issue would have been front and center in OPEC’s recent deliberations. As prices rose to $86 in October, the ramifications for emerging market economies looked dire. U.S. President Donald Trump took to twitter and both publicly and privately the U.S. made the point that oil prices above $65 would be problematic for the global economy. There seemed to be evidence to that view as economic growth and oil demand appeared to falter in the months when oil prices were climbing. Earlier this year, Saudi Arabia indicated that oil prices of $70 to $80 might be more to its liking, begging the question whether the kingdom’s own economic pressures would prompt it to view the world’s ability to absorb higher oil prices too optimistically. OPEC has used the vocabulary that it is just trying to “stabilize” oil prices or “balance” the market but those terms are meaningless without a reference to a price range at which that stability would be defined. Certainly, OPEC and Saudi Arabia specifically, can ill-afford pushing oil prices up to costs that would harm the health of the global economy and thereby crater oil demand more extensively. In that regard, the United States and Saudi Arabia should be seeing eye to eye. Moderate oil prices seem to be in OPEC’s long run interests, not only to avoid a massive drop in oil demand, like the one seen in 2009 during the world financial crisis, or like in 1998 from the Asian flu, but also to stave off the acceleration of competing technologies that might someday bring about a peak in global oil demand.  The higher the oil price now, the more unconventional oil and gas is likely to leave U.S. shores in the coming years, and the more large logistics companies and others will shift to optimization technologies that will limit oil use. There is also the bevy of alternative transport fuels waiting in the wings for the new oil price spike, including electric batteries, natural gas and hydrogen.   The very concept that these alternative technologies exist has changed the politics of U.S. oil-for-security alliances from within U.S. domestic political leadership circles. U.S. Democrats are far more vociferously questioning the usefulness of the U.S.-Saudi alliance these days. Importantly, Democrats are still highly committed to the clean energy transition so any arguments that Saudi Arabia is an important U.S. ally on oil prices falls on deaf ears. Oil price volatility is a defacto raison d’etre to support electric vehicles and the full left-wing agenda on clean tech. Thus, President Trump’s rhetorical comment that a failure to resolve U.S.-Saudi differences constructively could lead to $150 oil fails to stimulate concerns. High oil prices promoted by OPEC would undoubtedly hasten the clean tech revolution while at the same time stimulating U.S. jobs in the shale industry. If U.S. motorists don’t agree, the U.S. Congress has a piece of legislation to sell that would authorize the U.S. attorney to file anti-trust charges against OPEC for manipulating oil prices. That legislation weighed into OPEC’s deliberations in Vienna and might be one reason Qatar has chosen to quit the organization since passage of the legislation could affect U.S. infrastructure assets such as LNG export terminals and refineries owned by OPEC members. In early October, Qatar’s current energy minister told the press that peak oil demand was real and that the world was “pushing oil away as much as possible.” Other OPEC countries have expressed similar concerns privately, pitting them against fellow members who might favor policies that produce short term revenues. As Democratic leaders have been suggesting, there is a coming wave of energy innovation that could mean Saudi Arabia will play less of a role in changing global energy markets. The Saudi leadership is well aware of this existential problem and it is likely one of the reasons its role in global affairs has become more erratic. But while these technological gains are transforming global energy markets, they are not a spigot. Their exploitation requires the investment decisions of dozens of independent private companies who are following market signals and government incentives that have been unsteady of late. The gradual nature of the digital energy transformation means that temporary events, most recently the economic crisis in Venezuela and U.S. sanctions on Iranian oil, can give OPEC, and even Saudi Arabia on its own, substantial, albeit brief, market power. This proved an uncomfortable fact for U.S. President Donald Trump this fall and for the fragile global economy more generally. It is the reason the U.S. Congress is looking at legislation to defang OPEC. As the U.S. Congress debates various options, it should continue its policies supporting U.S. makers of electric cars especially because alternative engine technologies help wean the global economy off its reliance on OPEC oil more rapidly. As recent commodity price volatility and OPEC’s recent deliberations shows, that will take more than just exporting two or even three million barrels a day from U.S. shores given ongoing instability in many oil producing regions. In trade talks with China and European automakers, the Trump administration should shift to be a leading voice promoting advanced automotive technology, including for trucks, and adjust any proposed tariff rates accordingly to incentivize advance of new technologies. Congress should protect policies promoting advanced automobiles in the U.S. and consider stronger efficiency standards for delivery trucks and large freight vehicles. Congressional leaders should also press the Trump administration to quickly settle favorably with California on standards for diversified fueling options. The administration must give more weight to the fact that use of alternative fuels at home in cars and trucks (electricity, natural gas and biofuels) would free more U.S. oil for export to water down the importance of Saudi oil. It’s time to recognize that it is no longer wise to say the United States must back erratic actions of oil producing states because of their premiere role influencing global economic trends. More direct U.S. leadership to reduce the world’s vulnerability is needed, not only for one OPEC meeting, but for a more strategic future.

U.S. presidential jawboning about oil prices has continued to grab headlines this week, with President Trump telling Fox News on Sunday that the Organization of Petroleum Exporting Countries (OPEC) is manipulating the oil market and “better stop it.” The statement followed a previous tweet explicitly confirming a phone call with King Salman of Saudi Arabia regarding the kingdom’s agreement to put even more oil on markets than announced last week to counter turmoil inside Iran and Venezuela. The U.S. president’s unconventional approach contributed to an almost $2 drop in the price of international benchmark Brent crude Monday, as market psychology appeared to shift. That will likely be viewed favorably from the White House. But the transactional discussion offered on U.S. television that oil producing allies should offer accommodative oil export policies because “we are protecting them” laid bare a quid pro quo that could be problematical down the road given recent escalation of regional proxy wars. The United States may be encouraged by ongoing protests in Iran but turmoil can be unpredictable, and U.S. national interests can vary in certain respects from those of its allies. Close study of recent pernicious effects of cyclical swings in oil prices lends itself to sympathy for President Trump’s frustration. Given the circumstances of the financial turmoil and oil price collapse that followed the oil price spikes in 2008 and 2014, it should be pretty unnecessary to have to remind kings, presidents and emirs that an unstable oil market is bad for everyone, including their own people. For all the talk about resource wars, no shots were fired over oil when prices were rising in 1973, nor when prices hit $147 in 2008. That’s probably because for all of the handwringing about the oil “weapon,” commodity prices eventually correct themselves naturally like gravity, even in the face of politically inspired cutoffs. For OPEC, history seems not to be a teacher. Fuel switching, new drilling techniques, and structural destruction of long run demand reassert themselves when oil prices go up. That was certainly the explanation of the price collapse in 2014 to 2016. Moreover, in the future, countries like the United States and China are increasingly more likely to invest in alternatives rather than go to battle over resources either diplomatically or literally, especially in today’s digital revolution, where the potential for success is so high. The fact that few countries are willing to spend a trade chit on Iranian oil is a sign that times have changed. Oil producing countries are under budgetary pressure but, at least in the case of the Gulf countries and Russia, not enough to reverse course on high military spending and foreign adventurism. Venezuela should be the poster child for what could go wrong when governments raid the coffers of their national oil companies. The sad truth is that such suffering doesn’t actually seem to lead to regime change, just more repression. U.S. neoconservatives don’t seem to be learning that lesson either.   That said, I believe oil prices have entered a new phase where the traditional features like business cycles and geopolitics that normally dictate the ups and downs of oil prices are now intersecting more integrally with structural technological change. Digital disruption could bring a long run downward trend in energy costs over the coming decades, but that doesn’t necessarily mean “lower for longer” oil prices will be true for any particular month or year. If anything, digital innovation could be making the swings of the oil boom and bust cycle worse by shortening the time scale between up and down oil price phases. Private oil companies can bring new oil fields online with a rapid pace. Demand saving technologies are also readily available. To the extent that digital innovation does both simultaneously and seals a negative fate for individual national oil companies that cannot compete effectively in this new global context, it could bring higher oil prices at sharp intervals as oil supplies get disrupted from places where new investment is lagging, like Angola and Venezuela. In recent years, many important national oil companies (NOCs) have found themselves a victim of deteriorating budgets or violence—industries in Libya, Yemen, Syria, and Venezuela have been decimated. NOCs in Mexico, Brazil, and China have succumbed to localized corruption problems. The list is likely to expand over time. During periods when a major oil supplier goes down, OPEC (or some other group of oil exporters) are bound to find themselves with market power. That is why a volatility thesis based on the idea that producers can no longer interfere in markets is also likely incorrect for the time being, and the U.S. administration is smart to think about how to handle manipulation. Volatility can still come from exporter consortium attempts to goose prices. It may just be lumpy as technology continually improves to make itself felt and more frequent as digitization of everything from oil well development to energy efficiency gains pace. But if and when another major producer goes down (this time likely Iran), those left standing may attempt to garner some short-lived revenue as OPEC just did on the backs of Venezuela’s collapse. In the current upward business cycle, which has been stronger than expected, OPEC has certainly been able to jack up prices temporarily, unfortunately in all likelihood ensuring current global economic prosperity won’t last for long. For Russia, a culture that experiences long suffering of everyone together, instituting a downward global economic cycle could feel cathartic. For Iran’s hardliners, the temptation to push prices too high through acts of violence is likely a reflex to proving to others (read, American neocons) that they are still a force to be reckoned with. In the grand scheme of things, blowing things up to raise the price of oil will hasten the return of low oil prices which hurts the Iranian economy. Iran’s government has been preaching solidarity towards a resistance economy, albeit that message is looking increasingly uphill. Still, exigencies being what they are, the United States needs to be prepared to consider policies beyond calling upon Saudi Arabia, whose oil industry has struggled in recent years to add extra capacity. It is yet another reason why the United States should stay the course on advanced automobiles and other energy efficiency policies as well as modernizing the U.S. Strategic Petroleum Reserve. Rising U.S. oil production is not the same quality of oil as that of the Middle East, Venezuela, and Mexico so net flows in and out of the United States are necessary based on the current equipment in the U.S. refining industry which was designed to run imported oil. Sadly, recent consolidation of the SPR has left the United States in a worse position to help U.S. Gulf coast refiners. That problem needs to be revisited next time oil prices cycle down.   By the way, I am not conceding that the structural lowering of energy costs through digitization won’t be material. But it could entail a multi-year process. Every time oil prices go up, as they inevitably will repeatedly in a cyclical fashion, the deployment of new advanced technologies will accelerate accordingly, not only because we are in a period of revolutionary technological change, but also because other imperatives, like climate change and energy security, will give forward looking governments even more compelling reasons than the oil cycle to diversify away from oil. The United States needs to take that on board in considering its long run economic competitiveness. The U.S. Department of Energy’s new program for regional energy innovation, while underfunded, is a good start. Energy producing countries are starting to consider this digital structural change in their official thinking because the higher oil prices go, the more likely China and India are going to hasten policies to eliminate future oil demand, raising the chances of lower oil demand by the time 2025 or 2030 arrives. Governments are putting the infrastructures in place to ban the sales of internal combustion engines. European populations and their capitals care about climate change but renewable energy has also lessened the exposure to Russian energy. China is considering a ban on gasoline cars as part of its industrial policy. OPEC officials can say officially that they don’t believe in the peak oil demand narrative but a rise in oil prices above $100 now makes it all the more plausible than a drop to $20. At $100 a barrel, a ride sharing app that calls forth an electric ride will increasingly make sense in a world where new technologies are driving down the costs of solar, batteries, and even natural gas and clean coal. I am guessing that Saudi leaders understand this long run oil cycle threat. That is why they keep talking about decadal agreements with Moscow to stabilize oil prices. That’s good news for Vladimir Putin. But not because he believes he can ameliorate the oil cycle. He is just guessing that being the senior partner in an OPEC-like grouping will restore Russia to the stature it deserves. He is likely correct about that. It’s getting him yet another reset summit with the United States as energy has done several times before. The bad news for U.S. jawboning on the price of oil is this: There are two ways to get out of this painful pattern of oil price shock repetition and neither is likely to happen any time soon. Oil producers could start by spending more of their oil cycle windfalls on economic reforms, education, food and water security, and not buy as many armaments. For its part, the West, China, India, and ASEAN could make sure digital innovations like advanced and autonomous vehicles, drones and online shopping lower the oil intensity of their economies instead of the opposite effect so that economic growth does not promote as sharp an upward oil price cycle as in the past. I am not optimistic about either of those two things happening right away. For the time being, it will be hard for any of the parties concerned, to eliminate the oil cycle, including the U.S. president.  

As energy ministers from major oil producing countries gather in Vienna this week to discuss the stability of global oil markets, the variables that will dictate outcomes have rapidly shifted. Pre-meeting narratives that previously focused on the appropriate level of external private investment—either too much, in the case of U.S. shale producers, or too little, in the case of private sector international oil companies—look woefully inadequate to explain current oil market conditions. Instead, how to deal with the accelerating political and institutional breakdown of several national oil companies across multiple continents now stands out as a pressing structural challenge for the Organization of Petroleum Exporting Countries (OPEC) and U.S. policymakers alike. I highlighted this problem vis a vis Venezuela last March. Stated intentions to replace lost barrels from Venezuela and potentially Iran has brought acrimony back into the OPEC fray. U.S. plans to sanction Iran’s oil exports are the most recent publicly visible geopolitical irritant, but the history has shown that eliminating the endogenous geopolitical swings in the oil cycle takes more intervention and planning capability than even the most well intended partnerships can master, much less nation states whose relations have been punctuated by direct military threats or proxy wars. Talk of a sustained Saudi-Russian alliance that would be effective in eliminating the factors that could cause gyrations in oil prices seem overstated. All of OPEC’s fourteen members have flagship national oil companies (NOCs), that is, state-controlled entities that oversee their nation’s energy industry. Other important oil producing countries such as Brazil, Mexico, and Russia also have NOCs that dominate their oil and gas sectors. Many of these national firms are facing structural budgetary, corruption, or other internal political challenges, including attacks on facilities by local rebel groups, criminal gangs, terrorists, cyber hackers, and/or armed combatants in ongoing military conflicts.   As a result of these ongoing NOC difficulties, supplies from several OPEC countries, Venezuela, Libya, Iraq, Iran, Nigeria, and Angola have been volatile in recent years. In particular, the collapse of Venezuela’s oil industry and a slide in deep water oil production from Angola have been more instrumental to the market success of OPEC’s agreement with Russia and other non-OPEC oil producers than the producer group’s “planned” cuts in reducing excess inventories by almost 200 million barrels since early 2017 and pushing Brent oil prices up from about $55 to $75 a barrel. Cornerstone Macro noted in a recent report that oil stocks in industrialized countries experienced a counter seasonal decline of three million barrels in April, as compared to the more customary twenty million buildup on the heels of reduced global supplies and more robust than expected U.S. and global economic growth. While Saudi Arabia, Kuwait, the United Arab Emirates, and Russia did make promised output reductions to help tighten oil supply over the course of 2017, unintended production declines continue to be more material. Not only did oil output declines from Venezuela, Algeria, Angola, Ecuador, and Gabon amount to losses of close to one million barrels a day since early 2017, according to Citibank, markets have come to expect accidental supply disruptions from conflict prone oil regions in Libya and Nigeria. That reality prompted one prominent energy columnist to conclude that OPEC has become “an increasingly unreliable supplier of an essential commodity.” Whatever the outcome of the OPEC-non-OPEC Vienna group’s deliberations this week, it could turn out to be only a temporary fix to this more structural NOC problem than generally understood. Right now, OPEC spare productive capacity is highly limited. Saudi Arabia and Russia together would probably have difficulty adding much more than 1.5 million barrels a day to markets through the end of the year. Ongoing problems in Libya and Venezuela, combined with renewed sanctions on Iran, could possibly take more than that off the market. And what if a new supply problem emerges? Saudi Arabia and Russia are discussing longer run cooperation. What would that look like in a world where uncertainty plagues many national oil companies around the world, including, perhaps, their own firms? Does budget-constrained Saudi Arabia agree to divert billions in tandem with Russian firms to expand additional oil fields’ productive capacity down the road to capture future market share that could be available as NOCs in other countries continue to fail? If Saudi and Russia make capacity expansion pushes, what becomes of OPEC as a coherent organization? Will the Vienna group need to shrink in number? Conversely, if Saudi Arabia and Russia choose to make only a quick stop-gap measure just to keep markets from overheating in the next few months and don’t invest in new capacity, will they sacrifice future revenues to private oil and gas investors who can bring on capacity more quickly if NOC capacity continues to falter? The 2014-2015 price collapse has proven that a year or two of low prices won’t be sufficient to knock out growth in U.S. tight oil. That means restarting a price war in the short run isn’t an ideal option for OPEC, especially if those flooding the market do not appear to be able to survive the prolonged revenue drop that would make a price war option an effective threat. And my guess is that low oil prices also aren’t likely to be sufficient to knock out capital investment by the major international oil companies (IOCs). Those companies have started to pivot their strategies to direct their capital spending to activities that will be more productive than those pursued over the last decade when booking new large reserves was the priority. Rather, companies are focused on spending programs that can bring higher production more quickly, such as directing capital spending to shorter cycle field extensions and satellite field developments that can bring first oil into the market rapidly within one to three years (as opposed to mega-projects that took near a decade to develop). Companies are also developing new techniques to reduce the cycle time and costs on challenging green field projects.  Moreover, innovation in the private oil and gas sector is increasingly de-risking the landscape for future oil and gas investment for private investors. As technology improves, companies are going to be able to squeeze more barrels out of all kinds of existing known in place source rock, not just oil and gas from shale formations. The most recent example is the Austin Chalk where U.S. companies are rushing to test new drilling techniques to positive results.   There’s an additional rub. Saudi and Russian efforts could have trouble influencing intermediate oil demand trends. Even if the Vienna group takes production increase decisions this week that staves off any economically crippling oil price shock that could have sent oil demand into a tailspin, caution signs are already emerging that oil prices even at $70 a barrel are creating some economic headwinds. Markets are already nervous about trade wars. Reports are emerging that high fuel prices are hindering economies within the Euro zone and elsewhere. Rising fuel prices are visibly creating economic and political problems in India and other developing economies. And the United States needs strong demand growth elsewhere to manage its own economic issues. In the case of an unexpected global economic slowdown, OPEC supply disruptions could take a back seat again to “lower for longer” story lines about failing oil demand (potentially in the midst of rising U.S. production in 2019), which could make any discussion of a more permanent, workable Saudi-Russia oil alliance even harder to envision.

During his visit to the United States, Saudi Crown Prince Mohammed bin Salman inopportunely noted in an interview with Reuters news service that Saudi Arabia was “working on moving from a model agreement [for oil collaboration with Russia] for a year to a longer term—10-20 years.” In fairness to the Saudi leader, he could have imagined that the oil market stability implied by a long lasting oil deal with Moscow would be welcome news to the White House, whose energy dominance policy (and many U.S. jobs) depends on the economic success of the American shale boom. After all, the goal of a permanent oil alliance with Russia would be to eliminate the costly boom and bust cycle in oil that both destabilizes Saudi Arabia and underpins the historical cycle of global financial crises.  But last week when the details of what continued OPEC-Russian cooperation on oil could look like emerged, that is, oil prices nearing $80 a barrel or even $100, President Trump took to Twitter to make clear his view. “Looks like OPEC is at it again…” the President tweeted. “Oil prices are artificially Very High! No good and will not be accepted!”  Significantly, the President’s tweet did not come in the immediate aftermath of the Crown Prince’s interview with Reuters on decadal oil agreements with Russia or even after private indications of the Crown Prince’s hope that oil prices would rise to $80 a barrel to help along his initial public offering (IPO) of Saudi Aramco. The backdrop to the President’s first tweet about OPEC came as OPEC and non-OPEC ministers began their scheduled meeting in Jeddah amid overly ambitious statements about lofty oil price goals. Saudi oil minister Khalid al-Falih, in particular, galled some long time oil commentators by declaring, “I haven’t seen any impact on demand with current prices,” and added for emphasis that the world has more “capacity” for higher oil prices given declines in the energy intensity of global economic growth. The minister’s comment echoed similar Saudi statements made in 2006 just before the economically crippling rise in oil prices to $147 a barrel. Highly respected Bloomberg oil strategist Julian Lee's article with a chart showing that history was tweeted out with the apt twitter caption: “Down in Saudi Amnesia, They’re partying like it’s 2008.”  As often with President Trump’s tweeting, it has put forth a firestorm of commentary reading between the lines. Let’s break such speculation down, idea by idea. First is the issue that the White House was probably working on the assumption that his U.S. tour had convinced the Crown Prince to delay his IPO plan. The IPO has been an albatross around the neck of Saudi oil policy, which the White House might think needs greater maneuverability. That’s on top of the fact that $100 oil isn’t a solution to the problem of marketing 5 percent of the Saudi state oil firm. Markets would certainly not believe $100 was sustainable, even if that price could be reached again briefly. Such high prices even worry the U.S. shale industry. “We are going to lose demand. It’s going to move more toward alternative energy,” was how Scott Sheffield, chairman of the board of shale powerhouse Pioneer Natural Resources characterized $70 or $80 oil in response to a question from the moderator of an energy conference panel last Thursday.  Secondly, in constructing his OPEC tweet, the President could have been thinking about the important series of decisions that are on the U.S. president’s agenda for May, any one of which could affect oil markets. Most important, the United States is due in May to decide whether to take steps that would effectively re-impose oil sanctions against Iran. Historically, the Saudis have strategically increased oil production ahead of U.S. undertakings that might be a risk to oil market stability. Notably, they offered that courtesy to President Obama back when stronger sanctions were being mooted on Iran to pressure Tehran to accept negotiations towards a nuclear deal. Washington is also considering additional punitive measures against Venezuelan leader Nicolas Maduro, who has dismantled democracy and fostered a domestic humanitarian crisis through failed economic policies. Saudi Arabia has been mum on increasing production, should Venezuela's oil production problems get worse. If President Trump typed in his tweet just after his morning intelligence briefing, he could also have been thinking about the lack of wisdom for Saudi Arabia to be tightening the global oil market against the backdrop of the escalating Saudi military campaign against Iranian backed, Yemeni militias, which has increasingly put regional oil and gas facilities and trade routes at risk to asymmetric warfare. Saudi defenses recently foiled a Houthi drone that threatened the Saudi oil refinery at Jizan.  But there is no question that President Trump is aware that important U.S. geopolitical decisions that could affect oil prices are coming in the month of May, the kickoff to the U.S. summer driving season. The anti-OPEC tweet was presumably popular with the President’s base who care deeply about gasoline prices. That begs the question: Would a return to relatively high oil prices still hurt the U.S. economy? The answer is yes, but like many things, it’s complicated.  Energy economist James Hamilton, who is among the most cited academics on the subject of oil price shocks and the U.S. economy, noted in a pivotal 2009 paper that the high oil prices of 2007-2008 had significant effects on overall consumption spending and especially on purchases of domestic automobiles. With Detroit increasingly offering U.S. consumers high profit margin, gas-guzzling SUVs, high oil prices could be problematical for American car makers. Hamilton concluded that the 2007-2008 period of high oil prices can be added to “the list of recessions to which oil prices appear to have made a material contribution.” Along similar lines, economists at Deutsche Bank are forecasting that higher gasoline prices would erode the financial benefits low-income households gained from the tax cuts.  The other problem with rising oil prices is that they can create a deterioration in consumer sentiment, by signaling the possibility of economic slowdown or crisis. Research shows that there is a significant negative correlation between gasoline price increases and perceptions of individual well-being in the United States. With U.S. mid-term elections around the corner, Republicans could find it tougher to sell the President’s economic agenda in a sharply rising gasoline price environment.  Economic research from the U.S. Federal Reserve shows a more nuanced picture for oil prices in recent years, as the shale boom has been found as a driver to increased employment across many regions of the United States (Decker, McCollum, Upton Jr.) Fed economists have also touted improving energy efficiency and better monetary policy as an important factor that will inhibit negative economic effects from rising oil prices. But so far, the recent oil price rise has been gradual and has yet to hit tipping point levels that have, in past times affected consumer driving behavior.   If OPEC doesn’t heed the U.S. President’s call for more moderate intervention in oil markets, President Trump has several policy options at his disposal that go beyond twitter. The U.S. administration could opt to “loan” heavy oil from the U.S. Strategic Petroleum Reserve to specific U.S. refiners to protect them from any loss of supply from the deteriorating situation in Venezuela or the imposition of sanctions. Such a policy could be beneficial in two ways, by at least temporarily shielding American consumers from worsening supply problems in Venezuela and by replacing at the margin a similar quality of oil that has not been forthcoming from Saudi Arabia. It would also give the president political gains as being proactive on the domestic gasoline front, something several of his predecessors have done in similar circumstances.  More controversially, President Trump could choose to accommodate French President Emmanuel Macron by delaying a decision on Iran beyond May, waiting instead for the next decision juncture, which will come in July. Such a decision could be justified as giving European allies time to try to “fix” the Iran deal, before a final decision is taken whether to scupper it. That would also give the administration time to test whether it could press for a political fix to de-escalate the conflict in Yemen, leaving open a possible incentive for Tehran for cooperating. But any broader Mideast negotiation will invite Russian interference, which will be hard to counter without some assistance from U.S. Gulf allies who might leverage their close relations with Moscow on oil – hence yet another reason that President Trump’s tweet was strategically well-timed.         

As senior officials from the Organization of Petroleum Exporting Countries (OPEC) gather in Houston for the international industry gathering CERA Week, they will be listening carefully to speeches by the CEOs of the largest U.S. independent oil companies about the prospects for the rise in U.S. production in 2018 and 2019. Likely, they won’t like what they hear. U.S. industry leaders are saying U.S. shale production could add another one million barrels per day (b/d) or more on top of already substantial increases, if oil prices remain stable. Best C-suite guesses from Texas are that a sustained $50 to $60 oil price could result in a fifteen million b/d mark for U.S. production in the 2020s, up from ten million b/d currently. U.S. shale’s capacity to surprise to the upside is likely to leave OPEC producers with some soul searching to do as they consider their strategy for the second half of the year and beyond. OPEC has received some unexpected help to make space for rising Iraqi and U.S. oil exports from the sudden collapse of Venezuela’s oil industry where workers, faint from lack of food, are abandoning their posts to emigrate or worse to sell stolen pipes and wires to make ends meet for their families. Energy Intelligence Group is reporting this week that Venezuela’s oil production has fallen to 1.4 million b/d last month, down from 1.8 million b/d just last autumn. But ironically, a further collapse of Venezuela’s oil industry could make OPEC’s deliberations harder, not easier, if it ruptures the conviction of the current output reduction sharing coalition. If too many Venezuelan oil workers abandon their posts at once out of desperation, the country’s fate could more closely mirror Iran in 1979 when a crippling oil worker’s strike brought Iranian oil exports to zero and rendered the Shah’s rule untenable. The U.S. also continues to mull additional sanctions against Venezuela, including oil trade related restrictions, to pressure Caracas to restore democratic processes inside its borders. Trading with state owned PDVSA is becoming more difficult but Venezuela has been using U.S. tight oil as a diluent for its heavy oil. Historically, during many past oil disruptions, OPEC’s Arab members like Saudi Arabia and Kuwait have increased exports to prevent oil prices from skyrocketing. Kuwait especially is likely to argue that will be necessary to keep oil prices from going too high since it is keenly aware that the high prices of the early 2010s were exactly what stimulated the very U.S. shale oil investment and energy efficiency technologies that are plaguing the long run outlook for OPEC oil today. Studies on how digitization of mobility can eliminate oil use has led many organizations, including some large oil companies, to speculate that oil demand could peak sometime after 2030. The argument that the OPEC cuts need to be abandoned sooner rather than later could also sit well with Russia’s oil oligarchs who have been unhappy to see continued cooperation with OPEC that has left some one to two million b/d of potential Russian projects on hold. But Saudi Arabia could worry that a premature relaxing of the “super” OPEC coalition agreement could bring prices lower than the $70 it is targeting to keep its domestic spending on track and to position state oil firm Saudi Aramco for a successful five percent initial public offering (IPO) sale. It has been seeking a long lasting condominium with Russia to prevent a return to destabilizing competition for market share. Expanding U.S. exports have eaten away at Mideast sales to Asia. Russia is also looking to sell more oil and gas eastwards. All this leaves OPEC (and its partnership with Russia) in a quandary. Traditionally, OPEC’s Gulf cooperation council members, Saudi Arabia, Kuwait and the United Arab Emirates have made extra investments to carry spare capacity to respond to sudden supply shocks and/or to punish usurpers who could challenge OPEC for market share. But in the age of U.S. oil abundance, OPEC’s Gulf members are questioning whether this approach continues to make sense. In a world where peak oil demand is being mooted, will “the shareholder” (eg ruling royal governments) order national oil companies to spend billions of dollars to develop new spare capacity, even if it could not be needed? But if producers fail to make those investments and oil prices ratchet up to extremely lofty levels, can that propel a faster acceleration to low carbon electric cars, shared mobility services, and oil saving devices, hurting those very same oil producers even more harshly in the long run? China is clearly positioning itself to take advantage of such an eventuality with a multi-trillion dollar industrial export policy for renewables and clean tech of its own making. The overall uncertain situation has led to some incoherent commentary by OPEC leaders. On the one hand, some leaders talk about the global oil field three percent decline rate in near hysterical terms as potentially leading to an epic supply crisis in the coming years. They cite this risk as a reason to keep oil prices high. On the other hand, even as they sound that alarm, they are not willing to bet with their own pocketbooks on making major investments to plug that supposed hole. The alternative option for OPEC to restart the price war seems equally toothless, especially if those flooding the market do not appear to be able to survive the sustained revenue drop to make it an effective threat. Citi projects that even with expected declines in production in certain non-OPEC producing countries, continued increases from Brazil, Canada, Africa, and global natural gas liquids will overwhelm losses elsewhere, even without a higher than expected contribution from U.S. shale, assuming geopolitical events don’t create an unexpected cutoff of a major producer. It is in this context of confusion that the United States needs to consider the dangers of altering a suite of energy policies that are working. The United States is well positioned to supply individual U.S. refiners with heavy crude from the Strategic Petroleum Reserve (SPR), should it find that new sanctions or internal strife means those refiners have to abandon Venezuelan heavy oil imports. In other words, the SPR is not superfluous. Corporate efficiency standards for U.S. cars help constrain U.S. domestic oil use, freeing up U.S. refined products and crude oil for export and enhancing the role of U.S. energy production to constrain OPEC and Russian market power. Free trade agreements with Canada and Mexico are ensuring a strong nearby pipeline market for rising U.S. surpluses of natural gas. U.S. assistance for its clean tech industry prevents China from monopolizing benefits that can come to an economy when higher oil prices prompt countries to shift more quickly to energy saving technologies and renewable energy. The Trump administration needs to slow down in busting with tradition when it comes to energy. Some of the tried and true policies of the past are contributing to this administration’s mantra of energy dominance. They need to focus on the old saying “If it ain’t broken, don’t fix it.”

Saudi oil policy is undergoing a significant, yet subtle shift that is likely to have broader, strategic implications. The shift comes in the wake of a perfect storm of complicated existential threats facing Riyadh that have forced its government to accommodate new realities. In effect, for the time being, Saudi Arabia appears to have lost its flexibility on oil price policy and therefore will increasingly have to respond to geopolitical challenges in ways that don’t involve actively using export policy to lower the price of oil. A significant oil price drop now would be inconvenient to Saudi Arabia’s ambitious economic reforms, as well as threaten the success of controversial social reforms. This oil revenue conundrum could drive an already muscular Saudi foreign policy while at the same time, weakening the kingdom’s interest in the inner political dealings of the Organization of Petroleum Exporting Countries (OPEC). The threat to flood the oil market with its spare oil production capacity has for decades been a critical Saudi lever to muster oil production discipline and burden sharing within OPEC. OPEC, together with Russia, for now seem willing to consider a rollover of ongoing production cuts based on current improvements in oil prices but typically OPEC output cut discipline weakens over time. It remains unclear how the kingdom would be forced to respond if oil production increases from Iraq and other members to the agreement, not to mention the United States, start to eat at lofty oil prices come next spring. In the past, escalation in regional conflicts with Iran might have been met with policies designed to hurt Tehran via lower oil prices. But the Saudi response to the intercepted missile lobbed by Yemen-based Houthi rebels targeting the airport near the Saudi capital of Riyadh has been more strategic in nature. Riyadh quickly made it clear that the response it had in mind was more direct and militarily oriented, by announcing that the coalition would close access to all land, air, and sea ports to Yemen. The official Saudi Press Agency’s frankly worded statement on the matter noted that “Iran’s role and its direct command of its Houthi proxy in this matter constitutes a clear act of aggression that targets neighboring countries, and threatens peace and security in the region. Therefore, the coalition’s command considers this a blatant act of military aggression by the Iranian regime, and could rise to be considered as an act of war against the kingdom of Saudi Arabia.” Ironically, the more robust the kingdom’s military responses over time, the more likely that oil revenues will support the Saudi economy at home. The backdrop to the new Saudi oil price stance begins at home. In a series of recent interviews in late October, Saudi Crown Prince Mohammed Bin Salman made clear Saudi Arabia’s commitment to launch an initial public offering (IPO) of 5% of state oil monopoly Saudi Aramco next year and emphasized Saudi Arabia’s continued commitment to stabilize oil markets. Analysts calculate that the kingdom needs an oil price of roughly $60 a barrel for the Aramco IPO to meet acceptable revenues from the share sale. Events inside Saudi Arabia, including the recent arrest of at least eleven senior princes, former and current ministers, and dozens of top businessmen, sent oil prices higher Monday, raising the possibility that OPEC could even set its sights on $70 a barrel. It also created the prospects that any hole in the Saudi budget can be plugged by money seized from those arrested–fortunes estimated to tally in the hundreds of billions to trillions of dollars. A new anti-corruption commission has been empowered to “returns funds to the state treasury” and “register property and assets in the name of the state property.” The Saudi news comes in the wake of oil markets that have become more sensitive to geopolitical events in recent weeks, ever since a referendum on Kurdish independence temporarily disrupted oil exports from the Kirkuk oil field. The threat of a Venezuelan financial default is also weighing on markets. But it is also assumed by analysts and traders alike that an oil price drop would be inconvenient to Saudi Arabia’s ambitious economic reforms, including the Aramco IPO, leaving some speculators to believe they can go long in the oil futures market with impunity. This backdrop is in addition to the U.S. context where the U.S. President has made his commitment to the American domestic energy industry straightforwardly clear, implying yet another compelling incentive for Saudi Arabia to keep oil prices stable. President Donald Trump recently weighed in on the Saudi IPO on Twitter, saying it was important to the United States to float the shares on the New York Stock Exchange. Still, the longer term problem of price versus volume has been a durable, longstanding challenge for Saudi oil strategists over the years. Typically, Saudi declarations that the oil rich kingdom will support oil prices with its own production cuts invites other countries to free ride with extra production of their own. Russia has been a particularly notable free rider off OPEC cuts over the years, for example, promising cuts that tend to dematerialize over time in favor of export boosts. Conversely, Saudi attempts to expand or even protect its market share most often come at the expense of global oil prices. The late Saudi King Fahd removed his famous oil minister Sheikh Zaki Ahmed Yamani when the minister faced a similar delicate dilemma of achieving both a price and volume target. In the mid-1980s, the minister was instructed by the king to change course and end an extended oil price war that had been designed to get Saudi Arabia’s market share back. On some level, today's situation is reminiscent of that historical period. The Saudi IPO could create similar problems since investors will look for assurances that a steady volume of oil sales will reap predictable revenues that are also tied to the level of oil prices. That tension is in addition to other kinds of risks related to political stability in the kingdom and uncertainty about the long term demand for oil. Higher oil prices will invite a rebound in U.S. production at a time when Iraqi and Russian industry might also be poised to expand. That ultimately might be a longer term problem for Saudi Arabia, but one that doesn’t appear to be on the geopolitical radar today.