Tweets, sanctions and cartels - navigating oil markets

J.P. Szafranski, BridgeTower Media Newswires

Following energy commodity markets is rarely boring, but things seem more unsettled than usual lately. After mostly bouncing between $60 and $70 per barrel, West Texas Intermediate crude prices briefly moved swiftly into the mid $70s recently. Paradoxically, the upside price breakout occurred in the wake of a late June agreement between OPEC and other partners like Russia to raise crude oil output by 1 million barrels per day, a move that many expected would do anything but push oil prices higher.

In a February column, we encouraged readers not to fight OPEC because their words and actions are of paramount importance in charting the future path of oil prices. After consistent jawboning about maintaining existing production cuts through year-end 2018 to drain bloated inventories, OPEC leaders like Saudi Arabia Oil Minister Khalid Al-Falih began singing a different tune in the second quarter.
What changed? In early May, President Trump decided to withdraw from the Iranian nuclear accord and implement significant economic sanctions. It subsequently became clear that this time around the risk to Iran’s oil export capacity is even higher than in the circa 2012 sanctions period when waivers were consistently granted to allow U.S. allies to purchase limited amounts of Iranian oil with U.S. dollars.

Any such waivers will be much harder to come by this time with U.S. Secretary of State Mike Pompeo telling European Union allies that he is “not in a position to make exceptions to this policy except in very specific circumstances where it clearly benefits our national security.” The last round of sanctions removed about 1.2 million bpd of oil supply from the market. It could be more severe this time.

Perhaps unsurprisingly, just prior to the official Iran decision, Trump began publicly rebuking OPEC on Twitter for causing oil prices to be “artificially Very High! No good and will not be accepted!” It makes sense for Trump to apply pressure to allies like Saudi Arabia who depend on the U.S. for security and have a strong interest in a weakened Persian rival.

The combination of Trump’s political pressure, anticipated Iranian cutbacks, Russian oil producers chomping at the bit to increase output, along with accelerating declines from OPEC member Venezuela’s humanitarian and economic disaster (with output down 590,000 bpd from June 2017) created a cocktail for higher OPEC production from those members with enough spare capacity to pump more.

Barring other unanticipated oil supply disruptions, OPEC and others have the ability to fill the gaps caused by Iran and Venezuela. But it’s a Catch-22. With this increase in output, global spare capacity, a key to price stability “might be stretched to the limit,” according to the International Energy Agency. This introduces a risk premium to prices now and opens the door to a large future price spike, which would ultimately be bad for oil consumers and producers alike.

There is downside risk too. In the short run, the U.S. might pursue a large release of oil from its Strategic Petroleum Reserve to lower prices in advance of the fall’s midterm elections. A larger, longer-term risk lies in the ultimate impact of current international trade disputes, which could depress oil demand, especially in emerging market economies that account for nearly all future expected oil demand growth.

Saudi Minister Al-Falih seems to appreciate both types of risks. At the recent Vienna conference he stated, “We want to prevent the shortage and the squeeze that we saw in 2007-2008, we saw it again a few years ago as a result of lack of investment. But at the same time we want to prevent the severe downturns that choke the industry, cause bankruptcies, jobs being lost across the world.”

Here’s hoping Al-Falih can thread that needle. The energy industry and its capital markets have good reason to remain keenly focused on OPEC’s actions and words.


J.P. Szafranski is CEO of Meliora Capital in Tulsa (