Syria, OPEC, and Oil Prices
Energy Fact & Opinion
April 12, 2017
- Following last week’s U.S. missile strike on the Syrian air base at Shayrat, heightened geopolitical risk assessments combined with real (e.g., Libya, Canada) and potential (e.g., Venezuela) supply outages to push oil prices to their highest level in the last five weeks.
- While Syria itself is no longer a significant oil producer, its proximity to Iraq and the potential implications for both the expansion of the conflict within the region and uncertainty surrounding reactions from both Russia and Iran (which are significant oil producers) helped move Brent prices above $56 per barrel.
- While some analysts believe the run-up in prices to be temporary in nature and continue to point to both large, sustained global stocks and the resilience and recent increase in U.S. and other production, sentiment, at least for now, looks to be supportive of higher prices. Domestic refiners are coming out of seasonal maintenance, and U.S consumers are on the cusp of the summer driving season, suggesting that short-term demand for crude should remain strong.
- The Organization of Petroleum Exporting Countries (OPEC) is set to meet in late May to determine whether or not to extend the current supply cuts, and if so, under what conditions such a rollover would occur. In that context, political discord between Russia and Iran (supportive of the Bashar al-Assad regime) and Saudi Arabia and other Gulf producers (who oppose Assad) could fracture the agreement, an outcome that would undoubtedly lead to lower prices.
OpinionMarket fundamentals, available financing, geopolitical events, and sentiment have always driven oil prices. Bullish sentiment pushed prices higher this February. OPEC’s apparent cohesion and drive to rebalance markets, in no small part, fueled that rise, despite significant concerns over still growing stocks, resilient U.S. production, rising rig counts, and fears about tepid demand. Last month, concern over what was seen as overly bullish investor sentiment encouraged an unwinding of record long positions in the market, which subsequently led to a repositioning and price retrenchment.
Moving into April, the strengthened prospect for an extension of the OPEC/non-OPEC output agreement, the timing of the end of the refinery turnaround season, the onset of the driving season, the vulnerability of sustained production increases in Iraq, Libya, and Nigeria, and the continued erosion of the political and economic situation in Venezuela were already poised to once again directionally support higher prices. The U.S. attack on the Syrian airbase further underpinned and bolstered those views.
On May 25, OPEC ministers and non-OPEC colleagues will meet to decide if the current production agreement will be extended. While it is clear that the removal of upwards of a million barrels per day of output was directionally helpful in reducing the global stock overhang, the aggregate volume of the realized cuts was unable to rebalance the market in the second quarter as originally envisioned. Consequently, we and other market analysts have long assumed that an extension or rollover of the agreement would be both necessary and desirable from the producer perspective.
And here’s where the political discord could prove damaging. On the one hand, Russia and other non-OPEC participants have, so far, failed to achieve the reductions committed and needed. Russia’s commitments alone, while representing the lion’s share of the total non-OPEC contributions, to date have evidenced reductions of slightly more than half of its targeted 300 thousand barrel per day pledge (though, in fairness, Russia claimed to have committed to achieving those levels by the end of the quarter). Iran, for its part, is targeting further production increases, in part because its allotment was never really a cut at all. Saudi Arabia has cut above its pledged level as a sign of seriousness and commitment to the process, but here too, Minister Khalid al-Falih has been clear that a further extension would need to require better compliance from all parties and that he has no intention of carrying “free riders” on the back of the Saudi reductions. Nigeria and Libya were exempt from the reduction agreement, and Iraq, to date, remains above its targeted compliance level. OPEC now believes that rebalancing will still occur, but later than initially predicted. That said, one wonders if materially higher prices really work to OPEC’s longer-term benefit, as prices above $60 are likely to accelerate new investment in quick cycle production.
If Iran and Russia were to break ranks, it is unlikely that Saudi Arabia would agree to shoulder a larger share of the rebalance burden. Absent a major disruption (which is not out of the question), failure to agree to an extension would undoubtedly bring materially lower prices—to the detriment of all producers. In addition, such an occurrence would likely have a chilling effect on new investment in the sector. So the choices look to be a political schism that results in lower prices and greater economic pain for producing nations OR an “economics first” agreement that keeps producers (regardless of their political motivation or divisions) aligned—at least for the time being. We tend to believe that, politics aside, the economic benefits to OPEC producers of keeping prices from collapsing will ultimately drive the rollover decision.