Geopolitics of energy through oil prices

Geopolitics of energy through oil prices

Demostenes Floros | Geopolitical and economic analyst
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Despite the failure of the OPEC summit of June 2 in Vienna, in which the member states did not manage to reach an agreement on neither a production freeze nor a return to a production cap, the price per barrel has not decreased

In May, oil prices increased at around $4/b. In particular, ICE Brent quality opened at $45.38/b and closed at $49.57/b, reaching its highest at $50.28/b on May 30th. At the same time, NYMEX WTI opened at $45.53/b and closed at $49.21/b, reaching its maximum at $49.72/b on May 25. Both qualities marked their lowest on May 9, respectively, $43.52/b and $43.95/b. The wildfires in Canada –the fourth world oil producer with 4 million b/d, of which 2.2 million b/d from oil sands, and the first US oil supplier with 3.169 mb/d in 2015 – in addition to the political instability in Nigeria and Ghana brought the total supply outages to exceed 1.5 million b/d. Despite the failure of the OPEC meeting in Vienna on June 2, in which the member states did not reach an agreement, on neither a production freeze nor the re-establishing of an output cap, the price of the barrel did not drop, stabilizing at around $49-50/b. At the time of writing, Brent hits $51/b for the first time since October 2015, while West Texas Intermediate is above $50/b. During the same month, the euro significantly depreciated against the dollar because of the possibility that the FED may increase its interest rates in the near future. The European currency - after having reached its peak since January 2015 over the dollar, quoting 1.1569 €/$ on May 3 - consistently lost ground, pricing at the end of the month 1.1154 €/$. The slight depreciation that characterized the dollar at the beginning of June - which is completely due to the modest data provided by the US labour market that will probably exclude an increasing of the FED’s interest rates during the next meeting at the end of June - did not affect the oil trend. As in February, the reciprocal ratio between the dollar and the barrel did not appear.

The gap between Brent and WTI

On May 24, for the first time since September 2010, the price of the WTI ($49.01/b) overcame that of the Brent ($49.04/b). According to the US Energy Information Administration (EIA), during that period of time, the spread between the 2 qualities was the result of an oversupply at the Cushing terminal caused by the fracking revolution and the Canadian oil sands output. Furthermore, the dollar trend, the regional demand fluctuations and the geopolitical instability in Africa and in the Middle East affected the Brent quality more than WTI. The current fall in the US non-conventional production have been narrowing the spread. On April 29, the Russian ruble strengthened to a 5 month high over the dollar, bolstered by the Central Bank leaving the interest rate unchanged at 11%. During the same month, Russia’s international reserves - mostly comprising gold and foreign currencies - increased, month by month, by $4.5 billion in April, reaching $391.5 billion. Since then, the $/rubble exchange rate has moved between the range of 64/67 $/rubble.Currently, it is quoting below 65 $/rubble. With regard to the interest rates on the 10 year Russian Treasury Bonds, they have decreased to their lowest level since the beginning of the sanctions imposed by the US on the Russian Federation on July the 16 2014 and then by the European Union too. According to these data, it seems that the default of the Russian economy expected by United States did not happen.

Latest data and estimates on oil & gas

According to the data provided by the Oil Market Report on May 12, global oil supply rose by 250,000 b/d in April, reaching 96.2 million b/d. OPEC output was 32.76 million b/d, growing by 330,000 b/d, while non-OPEC production decreased by 80,000 b/d, 0.8 million b/d less on a yearly basis. Moreover, non-OPEC 2016 output is forecasted to drop by a further 0.8 million b/d to 56.8 million b/d. In comparison with April 2015, world output increased by just 50,000 b/d in April versus gains of more than 3.5 million b/d registered a year ago. Based on the figures published by the Energy Information Administration on May 16, US tight oil production is expected to decrease by 113,000 b/d in June. The total US oil output currently stands at 8.77 million b/d, down from its peak of 9.7 million b/d in April 2015. US crude oil production averaged 9.4 million b/d in 2015. Production is forecast to average 8.6 million b/d in 2016 and 8.2 million b/d in 2017 (0.2 million b/d higher than the previous statistic in April). In the first quarter 2016, global oil demand growth was revised upwards to 1.4 million b/d, due to the increasing consumptions in India, China and the Russian Federation. In particular, New Delhi’s oil demand grew by 400,000 b/d in the first half of 2016 in comparison with the same period of 2015 - when its Gross Domestic Product grew by 7.5% - representing nearly 30% of the global increase. In April, India imported 4.39 million b/d: only the US and China are importing more barrels. In 2016, world oil demand is forecasted to raise at around 1.2 million b/d, reaching 95.9 million b/d. With regard to the oil market, it seems that it is slowly moving towards a balance: the oversupply was at around 2 million b/d in 2015, 1.5 million b/d at the beginning of the current year and it is estimated at 1.3 million b/d for mid-2016. With regard to the European gas market, Gazprom’s deputy CEO, Alexander Medvedev, expects the company to deliver 165 Gmc3 to Europe this year, up from last year’s exports that reached 158.6 Gmc3. Western European countries accounted for about 82% of the company’s exports from Russia, while Central European countries took 18%. According to A. Medvedev, "this a very realistic figure, but I do not exclude the possibility of it going even higher if the autumn and winter are average or even mild." On May 31, during a press conference, Gazprom’s CEO presented export figures for the January-May period that were already 16% above 2015 yearly data. Countries like Turkey, in February, imported 1.8 Gmc3 less (-26.4%), compared to the same period of 2015. On the contrary, countries like Germany have been increasing their natural gas demand from Russia. "It was noted the last year broke the record of supplies from Russia, which grew by 6.6 Gmc3 (+17.1%). The upward trend continues to become stronger this year - 2 billion more cubic meters as compared to the last year (+19%) were already exported in the first four months of 2016," the Russian company said after the meeting of CEO, Aleksey Miller, with German Vice-Chancellor, Sigmar Gabriel. In light of the increasing demand for Russian energy products in Europe, the meeting participants stressed the importance of the Nord Stream 2 project as well. At the same time, the State Oil Company of Azerbaijan Republic plans to purchase from 3 to 5 Gmc3 of natural gas from Gazprom. SOCAR President, Rovnag Abdullaev, said, "We presented our proposals to the Russian company and await its response." In order to satisfy its domestic consumption, Azerbaijan must import gas from Russia if, at the same time, wants to respect the export gas contract that has in place with foreign companies. An example of this situation is well represented by the Azeri gas that must supply the Trans Adriatic Pipeline. However, a question arises: there is no doubt that the Mediterranean South Corridor will help the gas diversification of countries like Greece, Bulgaria and in particular, Italy but, taking into account the limits of the Azeri production, should it contribute to resolve the topic of their energy gas security?

Geopolitical assessments

In April, Iranian supply rose to 3.56 million b/d, a level last hit in November 2011 before sanctions were tightened (3.8 million b/d the first estimates related to the beginning of June). Iran’s oil production and exports increased slightly faster than expected following the lifting of sanctions: in fact, oil exports reached 2 million b/d, a strong increase from the 1.4 million b/d seen in March. This, in part, contradicts the statements made by Lukoil Vice-President, Leonid Fedun, who said at the end of March that, "Iran will not be able to seriously increase output without major foreign investment. In addition, Iran’s domestic demand is very high; this is a highly populated country. Well, they can add 300,000 to 400,000 barrels to the market, which is minor and is more about speculation". In March 2016, US crude oil imports reached 8.042 million b/d from 7.910 million b/d in February 2016 and 7.675 million b/d in January 2016. The last time that US crude oil imports surpassed 8.0 million b/d was in August 2013. Taking into account that the US average crude oil imports was 7.351 million b/d in 2015 (7.344 million b/d in 2014), it seems that the US oil import trend is upward and the country will probably need to purchase more crude oil from abroad. The months to come, will show us if the fall in North American tight oil and shale gas output will cancel the oversupply, or if the current market prices will lead to a stabilization of US production. Alternatively, the recovery of the barrel could restarts unconventional drillings, which need a price of at least 60 $/b. According to the data provided by the Federal Statistics Service Rosstat, in March the Russian Federation, having extracted 10.92 million b/d, outpaced Saudi production with 10.12 million b/d. On April 28, Bloomberg published an article which highlighted that Russian President, Vladimir Putin, "is on the verge of realizing a decade old dream: Russian oil priced in Russia."

This dream has, at least, 2 prerequisites:

  1. International oil traders must join the Russian emerging future market in order to disconnect the Urals from the world’s most used benchmark, the Brent oil price.
  2. Russia should move away from quoting petroleum in US dollars.

Is Russia really trying to achieve this goal?

With regard to the first issue, because of the protocol inked by the Russia-China intergovernmental commission for energy meeting at the end of May, Chinese companies have still expressed an interest in Russian Urals blend crude futures trading and in determining the price of long-term oil contracts too. Taking into account that the key factor is the volume of trading, the Russian benchmark could be interested for them said the director of investment firm Small Letters, Vitaly Kryukov, "The Chinese are buying a lot of Russian oil; they are shareholders in a number of fields. Working with them would be a great help". Meanwhile, Russian oil exports to China hit another record high in April, ramping up by 52.4 on an annual basis. Russian oil exports to China have more than doubled over the past five years, up by 550.000 b/d. As regards the second issue, it is not a case if Russia has been the most active buyer in the bullion market. The country has purchased 46 tons of the yellow metal this year, while China came second with 35 tons. According to Simona Gambarini, economist at Capital Economics, the major driver for gold purchasing by central banks is seen as a trend towards diversification away from the US dollar.