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By Jennifer Warren on Dec 10, 2013 with 3 responses

Frenemies in OPEC

More Supply, Competition and Friction Possible

News of Iran’s potential slow ramp up of oil supply resounded with a downward small ping in prices in late November, later to bounce back based on supply realities and economic growth. Iraqi oil supply keeps increasing, averaging about 3 million barrels per day, a new high in the last 20 years. Iraq plans to keep pumping — growing production 500,000 – 750,000 barrels more per day in 2014. Iraq’s output relative to OPEC production hovers near 10%, from around 7.5% in 2008. Iran’s contribution to OPEC production was around 12% in 2008, dropping in 2013 to 8.6%, according to a recent Wall Street Journal article.

“Al Arab Yantafiq lam yantafique,” said Mr. Charles Kestenbaum, a top Middle East expert and former U.S. Trade Specialist, in a November 25th interview, immediately following the news of Iran’s nuclear deal.  This Arabic expression is translated as: ”Arabs can only agree to disagree.” In late November, the Dallas Committee on Foreign Relations hosted Charles Kestenbaum, a veteran of Middle East affairs since the mid-1970s. In his quote, a common expression, lies the challenges ahead in the Middle East.

“Iran sanctions will not be sufficiently relaxed during the next six month period to have a major impact on Iranian production or world markets,” Kestenbaum notes in follow up commentary.  ”Word in Washington today [Dec. 4] reinforces that. It will take some time for the Majors to feel safe enough to go back or expand purchases, given how tough the sanctions regime has become and uncertain the relaxation will be.” Kestenbaum believes it will take months to sort things out, at minimum, just from the U.S. legal side. This does not include negotiating with the Iranians for the fields, production agreements, and even simple purchases will not restart right away. The sanctions are not lifted in any real way yet, which will come when the next stage of agreements is reached, suggests Kestenbaum.

Iraq’s gains have come at a time of Iran’s losses. Iraq’s intended supply increases could be dampened by security threats and aging infrastructure though. ”Iraq cannot expand production significantly because they have messed up negotiations and relations with the Majors in the past several years,” notes Kestenbaum. “Exxon Mobil was driven away from a concession in Rumailah with 8 billion barrels that could have been easily recovered.” Exxon negotiated for several years, won the concession, but never started production. Exxon Mobil signed an exploration and production agreement in Kurdistan, to the direct anger and opposition of the central government in Baghdad, says Kestenbaum. “This is a terrible sign for the Iraqis and their desire to produce more oil in the next several years. It isn’t going to happen in any dramatic volume.”

Some OPEC countries may have to give in to curtailing production to maintain quotas, with Saudi Arabia the most likely candidate. One analyst cites a $10 per barrel reduction in Brent crude prices if Iran’s export capacity is restored in full. Many OPEC members rely on $100 crude to stabilize their respective budgets, notes the WSJ article. However, the London-based Center for Global Energy Studies cites a minimum oil price of $85 per barrel for Saudi Arabia to cover its spending, assuming production of 9.6 m/b/d.  OPEC produced 30.01 m/b/d in November. The Saudis hold about one-third market share of OPEC’s production. The OPEC ruling is that they will stay production of 30 million b/d for the first six months in 2014.

The Saudis themselves say they will hold tight at 12.5 m/b/d to 2040 because of supply growth elsewhere. This is a signal that maintaining higher prices is a goal over market share. A Financial Times analysis suggests that investment is increasingly tied to replacing declining production from mature fields versus adding new production capacity. The most likely scenario for the OPEC cartel in 2014 is to stay output and agree on production quotas, if perceived or potential supply surges manifest. They want and need price stability, as do markets that absorb their exports.

U.S. Shale Impact

The U.S. shale oil boom has leveled the playing field, to a degree, in terms of U.S. imports. At the height of our oil import consumption in 2005, U.S. imports were 60% of demand; today imports are around 36%, as noted by an Economist Intelligence Unit report.

From roughly 500,000 barrels per day in 2009 to nearly 2.5 million in 2013, according to the EIA, U.S. shale oil continues to make a difference. The consultancy IHS expects 4.5 m/b/d of shale oil production in 2035. Overall, U.S. production was 10.24 m/b/d in 2013, according to the Paris-based International Energy Agency, and it expects growth to rise to 11.13 m/b/d in 2014, a fairly conservative estimate.

U.S. supply itself is not a huge threat to OPEC. A greater concern is the technology transfer and repeat performance of the shale oil ‘revolution’ elsewhere. When Kestenbaum was asked about the US shale oil proposition and how the Saudis really view it, he replied:

“Saudi Arabia is really more concerned than they are saying publicly. They understand that the technology is becoming more affordable and transferable. There are many areas around the world that have not been explored or even identified as having shale or secondary or tertiary capabilities related to hydraulic fracturing and directional drilling. Europe has a lot of shale. They are threatened by the shale revolution.”

Kestenbaum noted OPEC’s possible concern of the shale recovery efforts being repeated in their other export markets in Latin America and Asia, particularly China and Indonesia. These market are principle, long-term markets for OPEC. He suggests that these ‘secure markets are going to become less secure in next decade if they produce themselves domestically. “The Saudis are indeed concerned they face a long-term trend where both natural gas and enhanced crude recovery technologies will erode the global demand for Saudi crude/products,” he notes. “Additional production from Iran and Iraq in the coming decade will also erode Saudi control and prices in global markets, just as the local gas and crude expansions also have an impact on demand and prices.” Israeli gas, Brazilian gas and crude, and many other new sources could fashion a new order.

China, Russia, Argentina, Libya and Mexico have technically recoverable shale oil assets, GloablShaleOilas do many other countries. The following chart is sourced from the Energy Information Agency’s shale gas and oil assessment of June 2013. The estimates of technically recoverable resources are fractions in comparison to risked oil-in-place figures.

Economics in Driver Seat

In this ‘new’ hydrocarbon-plenty era, economics will drive investment decisions. Exploiting the shale oil and gas is relatively expensive. “It is a matter of cost as it always is, and the ability to deliver a BTU at a competitive price,” notes Kestenbaum.

Price volatility from negative supply shocks of years past is temporarily muted because of U.S. oil production. They are not eliminated, but the U.S. as a competitive player helps re-arrange the playing field. In the nearer term, demand shocks and dampeners, such as economic crisis or recession and U.S. policy paralysis that squanders a decent recovery, are catalysts for oil prices to fall.  The EIA reports that “energy use in non-OECD countries is projected to grow by 2.2% per year,” with their share of energy use “rising from 54% of total world energy use in 2010 to 65% in 2040.”

Growing developing countries will mop up excess oil supply in a medium time horizon. Further out on the horizon is the impact of greater fossil fuel consumption and whether the earth’s ecosystem can handle it. A number of firms across industries — Microsoft, General Electric, Walt Disney, ConAgra Foods, Wells Fargo, DuPont, Duke Energy, Google and Delta Air Lines — have factored the impact of a carbon tax into their long-term plans. ExxonMobil calculates a carbon tax of $60 per ton. The carbon tax issues circles back to Exxon’s 2010 purchase of XTO Energy, a natural gas producer, that benefits Exxon in a more gassy environment.

Changing energy portfolios among and within countries may and will likely factor into oil supply and demand equations in the future. In the short term, being less vulnerable to Middle East and North African political crisis — that shakes up oil markets — is one benefit of increased U.S. oil production.

  1. By Tiger-Pi on December 13, 2013 at 12:07 am

    There should be an international UN convention to decide on conservation of fossil fuels from all sources, tied to a carbon tax of per barrel of oil produced and to be equally shared by producer and user countries. Hopefully we can rein in excess fossil fuel production and restrict consumption along with doing something to reduce carbon emissions world wide.

  2. By ben on December 13, 2013 at 2:17 pm

    I consider OPEC members as neither friend or enemy. Rather, I view these nations as trading partners with self-interests influencing decisions impacting their respective economies. The western world is quick to caricature the oil-producing states as pariahs seeking to extract unfair advantage from the importing nations. Truth is, there is a reciprocal relationship here resulting from our a course that we charted in promotion of foreign/commercial policies of the past three-quarters of a century.
    And, yes, you reap what you sow. On that note, we engaged in some myopic views of how the world works in places beyond our own shores and cultural inclinations.
    To the extent that we’ve ever been tempted in a blush of Pax Americana to think we control the ebb and flow of global commerce, let alone the seamless rise and fall of nations, well, events of the past few decades have demonstrated considerable complication to such pat theories.

    The pending repprochement with Iran certainly has major implications for not only bilateral relations, but the interests of the international economy. Improved relations should be a good thing by contributing to more dependable and growing volumes of energy supplies from the region. This will, in turn, introduce opportunities (and challenges) for trading partners to explore optimal arrangements to revive economic growth within a framework of mutual benefits and obligations. This is not a zero-sum game that some are tempted to invoke in the hope of discouraging cooperation by fueling a specter of fear and mistrust. Fortunately, the average citizen in the street in both America and in the Persian Gulf recognize new-found advantages in promoting constructive relations and international trade.

    At the risk of some optimism (I tend to suffer from that), I believe we are in the early stages of progress within the energy sector that holds genuine promise for progress should we summon the courage to resist old instincts while embracing with clear-eyed reasoning our own national declaration: novo ordo seclorum. The future awaits. We shall see how well we choose.

    Thanks for the analysis, Ms. Warren.


    • By Jennifer Warren on December 13, 2013 at 3:51 pm

      The ‘frenemies’ refers to some of the relationships between OPEC countries, esp SA, Iraq, Iran. Thanks for your insights Ben. I completely believe in the need for good trade relations among OPEC suppliers and their consuming nations (though with strains in between). In fact, a US presence in ME oil development is good — to be engaged. Of course, firms have to weigh the risks and benefits of security threats, which are many. A number of US firms have been divesting some assets lately. It’s definitely a brave new world in oil supply, with a lot of scenarios possible.

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