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Winners and losers of cheap oil ahead of OPEC summit

The upcoming meeting of OPEC ministers in Algeria in late September has given rise to a great deal of speculation on possible beneficiaries and losers of a freeze deal.

Winners and losers of cheap oil ahead of OPEC summit
(Tuesday, September 27, 2016) 10:11

Numerous factors exert slight or major effects on oil prices ranging all the way from an official handshake between petroleum ministers of two oil-producing states to supply and demand conditions of the market. Once a luxurious product in world markets, crude oil is now being traded at what many might call an ‘unreasonable’ price. Falling oil prices, though very much appealing to drivers, has caused serious financial worries amongst countries whose economies are solely based on oil and major crude producers, while seeking to invest in and develop non-oil sectors, are also looking for venues to ease the pressure on oil prices.

Regardless of its roots and causes, the sharp decline in crude prices is the main issue at stake in oil industry and any amendment to the ongoing matter would entail complete and effective coordination among all states at the Organization of Petroleum Exporting Countries (OPEC), a goal which might seem far-fetched at the first glance given the turbulent diplomatic ties and rivalry among certain members. The forthcoming meeting of OPEC to be held in Algeria on September 26 is believed to offer an excellent opportunity to bring back oil prices to normal levels in order to make production cost-effective. The mere thought of a production freeze helped an uplift, even though slight in amount, in price of oil over recent weeks to further attest significance of the meeting of OPEC countries.

The need for a robust oil deal can be better felt if current circumstances of the market are observed more meticulously. Market experts have warned that any failure on the part of OPEC member states to reach a deal on freezing oil output could lead to catastrophic outcomes as prices are likely to fall below $30 per barrel. On the other hand, any effort to raise oil prices to over 60 dollars could encourage North American shale producers, who have now managed to cut down production costs, to boost production causing a significant glut in the market. America’s plan to boost production can be implied by return of drilling rigs which had been left abandoned for several years. Moreover, members of Organization for Economic Co-operation and Development (OECD), as an intergovernmental economic organization with 35 member countries, are constructing a growing number of storage tanks which foreshadows a rise in oil demands for the year 2017. Also, the amount of oil on water all around the world has hit a record high as well as that Mexico has increased its crude production significantly following the cessation of seasonal tsunamis.

Accordingly, and as it was mentioned earlier, OPEC members would be better able to control the oil market by reaching a consensus over oil freeze plan. Nevertheless, some states, with Saudi Arabia on top of the list, seem to ignore realities of the market by putting rivals, Iran in particular, under pressure at any cost.  Saudis, while possessing all geopolitical potentials to cooperate with Iran for both to rule over oil market, has been haplessly making efforts to prevent Iran from regaining its legal share in world markets.

Despite a recent claim made by the Saudi Arabian Minister of Energy, Industry and Mineral Resources Khalid al-Falih who said “freezing production is one of the preferred possibilities but it doesn’t have to happen specifically today”, several pieces of evidence exist to reveal that Saudis are in dire need of an oil freeze deal which would, in turn, ramp up prices.

First and foremost, 25 per cent of Saudi Arabia’s Gross Domestic Production (GDP) relies on oil venues while the figure for oil giant Iran stands at only five per cent. In other words, any decline in oil market will undoubtedly bring about the greatest loss to Saudis than it would do to Iran’s economy. Getting entangled in a proxy war against Yemen has proved to be far more exorbitant for Saudi’s than their initial speculations causing a significant reduction in its natural resources. Additionally, economy of Saudi Arabia is faced with a greater turmoil as a result of weak GDP growth and the current trend has led Saudi government officials to raise taxes in view of their inability to meet obligations towards workers. Meanwhile, the future of thousands of workers from South Asian countries, like Pakistan and India, is up in the air since reports reveal that the Saudi government has been incapable even of providing food for the labor forces indicating the very dire financial condition of the Arab country. Compounded with the decline in oil prices, these factors have forced the government to implement austerity measures and Saudi contractors, in turn, are facing numerous problems as a result of delayed payments.

More specifically, firing of a rocket by Yemen to a power-relay facility in southern Saudi Arabia in early September led some analysts to warn that the military war against Yemen by Saudi Arabia poses a high risk for the country’s oil production. Helima Croft, the head of commodity strategy at RBC Capital Markets said “the recent cross-border rocket attacks originating from Yemen are an ominous reminder of the dangers posed by Saudi Arabia’s 18-month military intervention in Yemen.”

Amid the drop in oil prices, Saudi Arabia's campaign in Yemen comes with certain overlooked risks to its oil sector, including the vulnerability of its oil infrastructure and pressures on its finances.

The rocket strike certified vulnerability of critical Saudi oil facilities and infrastructures including ARAMCO as the Saudi Arabian Oil Company, underlined the official at RBC Capital Markets, as the corporate and investment banking segment of Royal Bank of Canada.

Notably, the Saudi war in Yemen can cause grave pressures on its finances as regards security spending. Data from the Stockholm International Peace Research Institute (SIPRI), which tracks global arms expenditures, indicated that Saudis reached their highest level of military expenditure in 2015 comprising 13.7% of GDP share. Moreover, SIPRI noted that there were reports that 17% of total government overspending in 2015 was attributed to a $5.3 billion increase in military and security spending due to the campaign in Yemen.

Also in the current year, Saudi Arabia hosted the least number of pilgrims while Hajj occasion has always been counted a major source of revenue for the Arab state. A recent report the General Authority for Statistics (GaStat) revealed that the quantity of remote and local travelers has descended to a minimal number over the past ten years. GoStat reported that this year 1,325,372 remote and 537,537 residential travelers are expected to perform Hajj rituals giving an aggregate total of only 1,862,909 pilgrims while the figure for 2007 and 2012 amounted to 2.4 and 3 million explorers. All in all, the downward trend in the number of Hajj travelers would make Saudi Arabia even more dependent on oil income.

More importantly, unlike Iran, Saudi Arabia only produces crude oil lacking diversity in its energy basket. Only relying on crude oil has been the main cause for a 23 percent decline in SABIC shares this year. In January, Saudi Basic Industries Corp, SABIC, observed its shares falling after the company reported a drop in its annual profit. SABIC’s shares were traded almost five percent lower after the company released a report revealing a reduction of 19.57 percent in its full-year net profit. As a result, the Saudi Tadawul All Shares Index (TASI) closed down 5.44 percent to hit a five-year low since SABIC reported a net annual profit of 18.78 billion riyals (USD 5.01 billion) for 2015, as compared to 23.35 billion riyals for the preceding year.

Taking advantage of international sanctions against Iran and in a bid to overcome US shale producers, Saudi Arabia dominated the market. In other words, instead of lowering its production levels to maintain the balance in market, Saudis flooded the market with oil hoping to win the lion’s share though, much to their chagrin, oil prices dropped from $155.71 per barrel in June 2015 to a minimum of $43.16 per barrel in the current month. With present low crude price figures in mind, Saudi Arabia is obliged to find a way out since only last year their expenditures exceeded their revenues by $100 billion and the budget deficit for the ongoing year is expected to be no less than $87 billion. On top of that, the volume of foreign reserves for Saudi Arabia has dropped to $555 billion while the figure once stood at $737 billion hence their plan to raise $10 billion through an international bond sale.

Oil Market Report by the International Energy Agency (IEA) reported that Saudi Arabia has left behind the US and become the world’s largest oil manufacturer after adding about 400,00 barrels per day of low-cost production since May this year. Amid low oil prices, enjoying the largest share at the market would be a bitter pill to swallow, indeed.

On the other side of the spectrum lies Iran who, having been freed from sanction, is legally growing production and regaining its lost share of the market. Iranian oil officials, in comments backed by the Russian President, have repeatedly underscored that any deal on freezing output should allow room for some growth in Iran’s production until it reached pre-sanction levels. Iran’s precondition for a freeze deal does not seem to be a lofty expectation as the country has spared no effort in restoring production to a level that is similar to that of before sanctions were imposed and now produces roughly 3.85 million barrels per day being only 150,000 barrels per day shy of pre-sanction levels. A consensus also exists among all OPEC members, except Saudi Arabia, that Iran owns the right to be excluded from the possible production freeze since current production levels could limit Iran’s GDP growth.

Having taken an optimistic view, Iran has sent positive signals to a deal at the OPEC meeting realizing that upon approaching pre-sanction output levels, adding every barrel to production would require help of international companies. Relatedly, affecting the market psychology has been outlined by oil experts as a more important outcome of a possible freeze deal than its effect on supply levels.

Astute and shrewd, Iran has taken several other measures, in addition to boosting output figures, to gain profit from a myriad of opportunities present at oil, gas and petrochemical industries. One instance has been to benefit from the anticipated uplift in China’s crude demand due to an increase in transportation fuel consumption and its petrochemical industries in the second half of the year.

Furthermore, Iran has set to improve its bargaining power for crude sales as well as to support exports of Iranian crude in the Persian Gulf by increasing the country’s crude storage capacity in the Persian Gulf by 10 million barrels. Managing Director of Iran Oil Terminals Company (IOTC) Seyyed Pirouz Mousavi said given implementation of four new tanks in Kharg Termianl later in September, the total volume of storage capacity in the Iranian oil terminal has now reached 28 million barrels.”

In another attempt to compensate for the fall in crude prices, Iran has kept an eye on producing various types of crude oil to meet specific demands of different world refineries. Blending petroleum products as a common method to both attract more customers as well as to increase their satisfaction holds momentous in strengthening the marketing strategy of Iran whose crude oil is now being consumed by two score of world refinery complexes, said Executive Director for International Affairs at National Iranian Oil Company (NIOC) Seyed Mohsen Ghamsari.

Additionally, Iran stands head and shoulders above oil rivals for it enjoys one of the heaviest crude types on earth which opens a new window of opportunity to produce custom crude oil, tailored to meet its clients’ requirements. Even heavier than those of Saudi Arabia, Kuwait, UAE and Russia, the Iranian crude, with an API gravity less than 20°, marks a gateway to enter markets that can only process this kind of oil. Simply put, as an unshakeable competitor in the global oil market, Iran possesses all necessary assets to attract new customers since dozens of its offshore oil wells are manufacturing various types of light, heavy, sour and sweet crude oil.

Almost unaffected by fluctuation in oil prices, petrochemical industries have offered Iran one more advantage over rivals like SABIC who lacks diversity in its petrochemical basket. Relevantly, Fariborz Karimaei, Deputy Head of the Association of Petrochemical Industry Corporation, pointed to the leap in exports of Iranian petrochemicals to African countries saying “Iran’s share in deploying petrochemical and polymeric products to African states has climbed from 1 to 8.5 by the end of the previous Iranian calendar year (ended March 20) while resumption of petchem sales to European Union (EU) member states has also been put on the agenda.” Indeed, regaining the lost share of Iran’s petrochemical sale to Europe would prove to be a tough task since Iran’s share of the strategic market decreased from 12.5 percent in pre-sanction era to half a percent by the end of last year. Yet, Iran’s ability to locally produce a wide range of catalysts and polymer grits has been tantalizing enough for companies from Italy, Germany and Austria who have made requests to import Iranian petrochemical products.

While reports of prestigious international institutions reveal that Saudi Arabia is faced with the crisis of acute shortage of natural gas and that even the launch of a development project at Karan gas field cannot meet the needs of OPEC’s largest oil producer, Iran is now delivering the world’s cheapest gas to complexes to be consumed as feed or fuel. Also, Iran has put expansion of South Pars gas field on the agenda and if financial channels are regulated, daily production at the joint field can rise by 700 million cubic meters. In fact, mathematically speaking, a daily average of about 40 to 45 million liters of several Iranian oil products have been exported to various world countries since the beginning of the current Iranian calendar year and the capacity for export of Iranian petroleum products has reached a total of 400 thousand barrels per day while the figure is expected to hit 500 thousand barrels per day upon implementation of new harbors at Mahshahr Terminal.

To recapitulate, the market has observed OPEC’s crude production at a record high figure of 33.47 million barrels per day as Iran, freed from sanctions, reached a threshold of about 3.85 million bpd in August and shipments from Saudi Arabia also increased to 10.2 million bpd. Still, Saudi Arabia considers Iran as a major competitor and Saudi Oil Minister Khalid al-Falih previously said that Iran’s production was already high enough, a comment which indicates a fear held by Saudis that output freeze would mean a reduction in their market share. Nevertheless, several factors exist to reveal that Iran’s rivals, Saudi Arabia in particular, would suffer more from failure to reach a freeze deal which would otherwise ramp up prices since Iran has already stood the test of time in dealing with low crude prices.

For one thing, Iran has seen and survived worse days than other producers since international sanctions were imposed in 2011, much earlier than the sharp decline in crude prices in 2014, and cut Iran’s production to the shockingly low volume of 1.3 million bpd. Also, unlike the past, majority of Iran’s oil and gas production are now consumed domestically thanks to an emerging diversified economy. Iran’s inclination towards industrialization in energy sectors such as petrochemicals, cement and steel have led to substantial upswing in the country’s real growth domestic product as compared with the time imposed war against Iraq taking domestic production of oil and natural gas from 10% then to 76% now.

Expansion of non-oil exports as well as recent release of blocked assets have brought Iran more decisive advantages over its rivals. Statistics indicated a reduction in Iran’s non-oil trade deficit from 33.8 billion dollars in 2010 to only 2.7 billion dollars in 2015. Despite the fact that still 29 per cent of the Iranian government’s income is accounted for by oil revenues, the figure resides way lower than the levels for other oil giants.

In conclusion, a leading rival of Iran inside the region Saudi Arabia seems to experience much further hardship if prices continue to remain at low levels since Iran enjoys the upper hand when it comes to withstanding low crude oil prices regardless of the outcomes of forthcoming Algiers meeting.

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