OPEC’s ministerial meeting on 6 December will have a seismic impact on the outlook for global oil markets. OPEC has been unnerved by a 30% fall in crude oil prices in the past two months on expectations of lower oil demand due to a Chinese economic slowdown, spectacular growth in U.S. shale oil supply, King Dollar’s chilling impact on the commodities complex and long liquidation of Brent/West Texas oil futures by Wall Street hedge funds. In addition, the Trump White House has pressured Saudi Arabia to lower oil prices as the kingdom faces its worst diplomatic crisis since 9/11 and has offset tougher sanctions on Iran with waivers to countries like China and India that import Iranian oil, both bearish data points for the oil bulls. West Texas is barely $50 as I write, demonstrating that the oil market is skeptical that OPEC and its allies (mainly Russia) will be able to rebalance the market and nudge oil prices significantly higher at Vienna. Even dovish smoke signals by the Powell Fed and a late November surge in global equities has not had a comparable impact in the oil market.
Saudi Arabia announced that it would cut its output by 500,000 barrels a day to stabilize global oil prices in early November. This was not enough to mollify the oil bears in a global wet barrel (physical crude) market where 100 million barrels is used by consumers worldwide each day. The psychology of the oil market is so bearish that traders want to see a Saudi Arabian plus Russian led production cut of at least two million barrels a day. Will Saudi Arabia and Russia be able to persuade two dozen OPEC and non-OPEC oil exporting countries to cut two million barrels a day in black gold export at a time of fiscal and geopolitical stress? Absolutely not. No wonder November 2018 alone witnessed a 20% free fall in oil prices.
There are wide asymmetries of power, production costs, spare capacity and geopolitical orientation among the world’s major oil exporters. Saudi Arabia’s production costs are below $10 a barrel and it commands the bulk of OPEC’s spare capacity, the reason the kingdom has historically stabilised oil prices as OPEC’s swing producer. Saudi Arabia has also been dependent on Uncle Sam’s “security umbrella” ever since King Abdul Aziz met President Franklin Roosevelt on a warship in the Suez Canal in 1945. Russian production costs, in contrast, are among the highest in the world and the Putin Kremlin’s relations with the West have plunged to post Cold War lows, with the latest provocation its seizure of Ukrainian ships in the Sea of Azov. Russia (plus its ally OPEC member Iran) and Saudi Arabia supported opposing sides in the Syrian civil war.
OPEC must announce a credible, significant “shock and awe” output cut when its ministers meet on 6 December in Vienna. Nothing less will appease the oil bears at a time when financial markets fret about slowing global economic growth and even a recession if Federal Reserve rate hikes engineer a inverted yield curve in U.S. Treasury debt. In retrospect, Saudi Arabia’s decision to increase output last June to reduce the risk of an oil shock given Trump’s planned new sanctions against Iran backfired when the U.S. import waivers failed to choke Iranian exports. If OPEC fails to announce an output cut in Vienna, the world faces the very real risk of a protracted supply glut and a catastrophic fall in oil prices, possibly to the $30 lows seen in February 2016. This is not a welcome scenario for Saudi Arabia, whose budget breakeven price of oil is $90 and less so for other Middle East oil producers whose budget break evens are above $120 a barrel. Saudi Arabia, Kuwait and Abu Dhabi must lead a credible output cut pact with Russian support to make it credible. The stakes could not be higher at Vienna.
