The great crude oil game enters a new chapter

TXF News: The week that was

High crude oil prices look set to continue despite efforts to increase production. At the same time, argues Jonathan Bell, we are seeing a greater strategic use of crude.

The move away from fossil fuels continues apace. But at the same time, the hydrocarbons market, in all its forms, will continue to rule over much of our activities for many years to come. Consequently, we will continue to heap strategic value on the hydrocarbons sector.

Take the crude oil market – the rapid growth of the production of shale oil/gas deposits in the US and Canada, the push with natural gas, the development of renewables, and the volatility of the crude oil price over the past few years has allowed some observers to expect crude oil to play a more diminished role in the global energy game. Not so, it has kept us all on our toes.

Just look at the past ten years; in July 2008 Brent hit $145 per barrel, and in June 2016 Brent sunk to $27 briefly. Perhaps 2016 can also be seen as a pivotal year as US sanctions were eased for Iran and that country resumed oil exports. Oil price volatility has always been present despite attempts by OPEC to control the level of supply.

Of late, the production agreement between Saudi Arabia – the big OPEC ‘swing’ producer – and non-OPEC Russia has managed to keep prices quite stable but gradually rising, despite appeals from the US to Saudi to increase production. President Trump is keen to keep oil prices down because of US consumption at the pump and the forthcoming mid-term elections. Currently, Brent is trading at just under $82 and WTI (West Texas Intermediate) at $72.

However, the crude oil supply/demand game has now entered a new stage as the reimposition of US sanctions on Iran is seriously denting that country’s ability to export – or possibly more correctly, US political pressure is preventing countries from purchasing Iranian crude. Data shows that Iranian oil shipments to Europe fell from 843,000 b/d in August this year to 422,000 b/d in September. This plays right into the hands of Saudi Arabia, which is relishing the diminished economic returns for Iran. Russia has also been filling its state coffers to make up for previous years.

The International Energy Agency (IEA) in early October also urged oil-producing countries to ramp up production in order to try to rein in oil prices. However, both Saudi and Russia are already producing in large volumes. The Saudi oil minister, Khalid Al Falih, recently said that his country’s oil output was running at 10.7 million b/d, equal to its highest level on record. The last time Saudi was pumping at 10.7 million b/d was in November 2016 when crude was below $60 per barrel. Russia has also pledged to increase production, which is already running at a record level of around 11.4 million b/d.

Interestingly, the Saudi oil minister also recently announced that his country would invest $20 billion in upstream oil in the next few years in order to maintain and further increase spare production capacity.

In other developments which could impact the crude oil market, the recent disappearance of the Saudi journalist, Jamal Khashoggi, at the Saudi Arabian consulate in Istanbul, and the allegations that he was murdered within the consulate is having serious political ramifications and could well impact the oil market and crude oil price.

Saudi is also coming under increased pressure over its war in Yemen and the devastation its air strikes are having on the civilian Yemeni population. There is concern however that Saudi will use the level of oil supply as a weapon to try to ensure it is not impacted by sanctions in the face of international condemnation. The weaponisation of oil has been used before and will surely be used again!

Ultimately, Saudi Arabia believes it can do what it likes and get away with it. It already largely has the blessing of the White House as part of the attempt to counter Iran. But for too long the West and the main arms suppliers to Saudi Arabia, the US and the UK in particular, have largely ignored what Saudi has been, and continues to do, in Yemen. Similarly, the stance that Saudi (and the UAE) has taken in the diplomatic rift with Qatar is something that has also added to tension in the region.

Commenting on the Khashoggi case and its potential impact on the oil market, Ivan Petrella, associate professor at Warwick Business School in the UK, says: "The Jamal Khashoggi case is adding fresh uncertainty to the oil market. The producers had recently found an agreement on oil production and the focus was on the uncertainty on the demand side. If the Khashoggi case turns into a full-blown diplomatic crisis the uncertainty on the supply side is likely to add pressure to oil prices, sustaining the bullish movement of the market of the last year."

Heightened focus on strategic stockpiles  

Many countries have always had a desire and need to keep crude oil in strategic stockpiles. Usually these stockpiles are to meet domestic demand, but there are other reasons also. One might expect the issue of strategic reserves to be particularly heightened when there is increased conflict, and currently this very much appears to be the case.

Most recently, the UAE has started construction on a big oil storage facility in a network of caverns. The Mandous facility is located in the emirate of Fujairah and has the capacity to store 42 million barrels. The ‘secret’ project is being overseen by the state-owned Abu Dhabi National Oil Company (Adnoc). The $1.8 billion project to construct the facility is understood to have been awarded to South Korea’s SK Engineering and Construction. The stockpile, which will house different types of crude, will act as a buffer if there are disruptions to supply.

The UAE has also done a strategic deal with India under which it is housing crude at sites in India. Back in May this year, Adnoc delivered the first shipment of crude from UAE for storage at India’s Mangalore underground strategic storage which will act as insurance in times of emergencies. Under an agreement with Indian Strategic Petroleum Reserve Adnoc will lease out part of the Mangalore storage and store about 5.86 million barrels of crude oil at its own cost.

In a joint statement, the companies announced: "The agreement stipulates that during an emergency, the Indian government can use the entire available crude oil stored by Adnoc in the Mangalore facility for its use. Further, as an incentive for storing crude oil at its own cost, the agreement allows Adnoc to sell part of the crude oil to Indian refineries during normal times."

It also added: "With the recent acquisition of 10% stake in UAEs Lower Zakhum offshore producing field by Indian public sector oil and gas companies and the investment by Adnoc in the Indian strategic oil facility, the hydrocarbon sector engagements between India and UAE have transformed from buyer-seller relationship to strategic partners in the energy sector."

In June this year, India also announced plans to create two new underground oil storage facilities - at Chandikhol and Padur - with a total capacity of 48 million barrels. 

Putting all of this into context, of course the two countries with the two biggest strategic oil stockpiles are China and the US. China has most of its oil stored in above ground tanks and has made heavy investments in these facilities in recent years.

The US currently has around 660 million barrels of oil in its strategic stockpile in underground caverns in Texas and Louisiana. Trump has proposed the sale of half of the stockpile to help towards cutting the budget deficit. Last year’s federal budget agreement mandates the Department of Energy to sell 25 million barrels of crude in the three years through 2019. It plans to continue sales through 2025. But, it is argued that this level of sales will do little to calm the oil market and very little to reduce a US budget deficit expected to be around $1 trillion in the fiscal year ending in September 2019.

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