If Trump’s problem is Opec, his solution is Iran

This article first appeared in The Edge Financial Daily, on July 9, 2018.
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US President Donald Trump has once again taken to Twitter to slam Opec for driving up oil prices. The group is a useful scapegoat on which to pin the blame for rising gasoline prices at home, but getting it to pump more crude will not bring them down for long. The way to really lower prices is for him to change his policy on Iran.

Unfortunately, that is not likely to happen, so oil prices could well keep rising. Oil prices have climbed by more than 50% in a year, and very nearly touched US$80 (RM323.20) a barrel last week as traders anticipated that the world’s margin of spare production capacity available to offset supply disruptions is set to seriously shrink.

They know something that the president either cannot or will not understand: When sanctions on Iran come into force in November, producers do not have the scope to make up for its lost output. If Trump succeeds in halting all of Iran’s oil exports, they will have to replace 2.7 million barrels a day of Iranian supply. That is a big hole to fill.

And if they cannot do it, the cost will be steep. According to Bank of America Merrill Lynch, a complete shutdown of Iranian sales could push oil prices above US$120 a barrel if Saudi Arabia cannot keep up.

In Trump’s world, the gasoline prices he focuses on should already be headed down. Last Wednesday, Saudi Arabia said it pumped about 10.5 million barrels of crude a day last month, preempting the deal reached among the Opec+ group of countries in Vienna. That is an increase of about 500,000 barrels a day from May, making it the biggest month-on-month jump in the kingdom’s output since June 2004.

But there is a problem. The production jump ought to have shown up as a similar surge in total Opec output. It did not. The increase was entirely overwhelmed by declines elsewhere in the group. Add in the loss of 350,000 barrels a day of Canadian supply from an explosion at an oil-sands upgrader in Fort McMurray, and the entire boost from Saudi Arabia is gone.

The simple truth is there is not enough spare production capacity in the world to replace the complete loss of Iranian exports. Saudi Arabia can boost output to 11.5 million barrels a day immediately and go to 12.5 million in six to nine months, Crown Prince Mohammed Salman told Bloomberg in 2016. He has said nothing since that interview to suggest the figures have changed. Others are less optimistic — the International Energy Agency said at the time that going beyond 11 million would require boosting costly offshore production.

The most that Saudi Arabia has ever pumped on a monthly average basis is 10.72 million barrels a day in November 2016, according to official figures provided to Opec. Anything beyond that is uncharted territory. That does not mean it is impossible, just uncertain. All we can say for sure at this point is that it has around 200,000 barrels a day of proven spare capacity immediately available.

There may be a couple of hundred thousand barrels a day in the United Arab Emirates and Kuwait, and as many as 500,000 in the neutral zone shared by Saudi Arabia and Kuwait. Fields there have lain idle since 2015 after Saudi Arabia closed them on environmental grounds. There are now suggestions that they could be reopened in the coming months.

The rest of Opec may hold another hundred thousand barrels of spare capacity and, outside the group, Russia has already begun to boost its production. Russia has never shared an official estimate of how much idle production capacity it could restore. Forecasts vary from 215,000 barrels a day from Renaissance Capital to some 500,000 barrels seen by state-run Gazprom Neft PJSC, the nation’s No 3 producer.

But that is about it, around 1.5 million barrels a day of immediately available oil to replace what Iran will not be pumping. That is not enough.

Releasing oil from the US Strategic Petroleum Reserve (SPR) might provide a theoretical short-term answer, but that will not work. It is in the wrong place. American refineries are already running nearly flat out, so any additional supply from the SPR would have to be exported and it would take a couple of months to get it to the Asian refineries who would need it.

So when Trump tweets this:
Donald J Trump @realDonaldTrump The Opec Monopoly must remember that gas prices are up & they are doing little to help. If anything, they are drivi… twitter.com/i/web/status/1… it is clear that, as energy consultant FGE said in a report last week, “either President Trump’s advisers do not understand the oil market or he simply just does not listen to them.”

There is one way the president could quickly achieve lower prices, and it is staring at him in the mirror. He could reimpose sanctions on Iran in a much more gradual manner, instead of all at once on Nov 4. Sure, it would prolong the process, but it would also ease the pressure on oil markets and those all-important gasoline prices. Unfortunately, patience does not seem to rank highly as one of the president’s virtues.

Pumping more crude into the market may seem as if it ought to ease fears of a supply shortage when Trump’s Iran sanctions begin to bite — but any relief will be shortlived. Oil prices will reflect this. — Bloomberg