Oil prices have rallied more than 2 percent this week after the Trump Administration canceled the waivers given to major consumers of Iranian oil – including both China and India which together account for almost 50 percent of the Islamic Republic’s exports. Trump’s decision will undoubtedly have unforeseen consequences for the oil market. However, in the short term, there are two key questions that must be addressed: One, now that the United States is the largest producer of oil in the world, will Trump ignore higher oil prices and focus less of forcing Saudi Arabia to increase output? And, two, if the United States does continue to press the Saudi Kingdom to make up for lost oil exports by Iran; will Saudi Arabia acquiesce to Trump’s demands?
There are three factors to consider before reaching a conclusion to our first question. The first factor is that we cannot simply view the above scenario in terms of each country being a net importer or net exporter. The United States continues to import oil and while U.S. shale producers cherish higher oil prices, its consumers do not. Recently, U.S. gasoline prices reached $3 per gallon and prices are likely to go higher again during summer driving season.
The second factor is the fact that U.S. imports 11 percent of its total oil consumption. Although this figure represents the lowest level since 1957, it doesn’t mean that importing this 11 percent crude at higher prices won’t influence the U.S. economy. Moreover, the interconnected nature of the world economy shows that an increase in prices of such an important and widely used commodity can increase the cost of doing business for a huge number of companies (crude oil has more than 4,000 by-products) and, as the U.S. has a huge trade deficit, its economy would likely struggle as a result. Inflation, as seen in the 1970s, might rise as well. As the U.S. Treasury-yield just inverted for the first time since the 2008 recession, it is indeed an unfavorable scenario.
The third factor, and probably one of the strongest, is “demand destruction” (a level of price at which the demand for a certain commodity starts to decline gradually). The International Monetary Fund (IMF) has recently revised down its growth rate for the global economy from 3.5 percent to 3.3 percent: a figure which is the lowest since the 2008 global financial crisis. A brewing but not-yet total trade war between the world’s two largest economies – the U.S. and China – does not appear to be approaching a quick resolution. Concerns in the global capital and financial markets regarding the health of the Eurozone are growing, particularly with the political drama surrounding Brexit negotiations between the United Kingdom and the European Union.
A fair-minded observer may conclude that Trump will lobby against higher oil prices and will, therefore, press Saudi Arabia to play its traditional role as OPEC’s “swing producer” to stabilize the global market in crude. However, this opens up a whole new dimension. Saudi Arabia has been spearheading the production cuts that have, to some extent, balanced the oil markets. Being the de facto leader of the OPEC cartel, it cannot simply overrule the wishes of the cartel’s members solely to oblige Trump’s demands (as it did when Trump re-imposed the sanctions on Iran last year). Moreover, Saudi Arabia has acknowledged that from a budgetary standpoint it needs an $80 per barrel price in order to fulfill its plans for an array of new investments (such as the so-called National Transformation Plan). Market observers opined that the current OPEC deal, which reduced the group’s output by 1.2 mbpd, can make or break the price, with estimates as low as $40 if cuts fail to continue.
U.S. Secretary of State Mike Pompeo assured, when announcing the cancelation of waivers, that “other suppliers” will increase production to make up for the Iranian crude withdrawn from trading. This clearly signals that the U.S. Administration expects OPEC (read: Saudi Arabia) to increase production. Therefore, we might see a conflict of interest between the U.S. and Saudi Arabia as the latter desires a higher oil price while the former quite the opposite.
As we near OPEC’s June 19th technical meeting which will be followed by a general meeting between the OPEC and non-OPEC producers, Saudi Arabia will find it difficult to navigate through this situation. Increasing production will certainly disappoint other OPEC members and may, in the future, affect the Kingdom’s credibility within the group. Not doing so will draw further demands from – usually delivered through his favorite social platform, Twitter — with the effect of furthering downward pressure on global oil prices.
Hovering over all these considerations is the upcoming U.S. Presidential election in 2020. According to Rex Preston Stoner, a Paris-based U.S. industry observer, “Trump’s priority over the coming eighteen months will be his reelection effort and, if he follows his senior advisors’ recommendations to focus on the United States’ robust economy, then tangible domestic concerns – such as lower gasoline prices – may override many, if not most, foreign policy considerations.”
Therefore, as the United States’ summer driving season sets in and oil rallies, Trump will certainly put pressure on the Kingdom to increase production to offset the lost production from Iran and stabilize the prices. For the Saudi oil producers it is going to be a busy summer, indeed!
By Osama Rizvi for Oilprice.com
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