The oil price plummeting, again. A fragile deal in an oversupplied market. Regional rivals and their proxies, the new swing producer and a struggling cartel.
What is the potential impact of the Gulf crisis on the oil market?
When on June 5th Saudi Arabia, Egypt and the UAE announced their decision of cutting diplomatic ties with Qatar, accusing the tiny gas-rich country of financially supporting international terrorism, many thought at the impact of such political tensions on the oil market.
Despite the limited oil production of Qatar (600,000 b/d, less that 1 percent of global oil production), it is still an important country of OPEC, partly due to its membership in the Gulf Cooperation Council.
The GCC is the strong core of OPEC, with GCC member countries aggressively defending the interests of the oil cartel and diligently following the line suggested by its leader, Saudi Arabia.
The decision taken by the Saudi-led alliance of cutting all diplomatic ties with Qatar sparked worries of oil supply disruptions within the Middle East, making prices rebound and reserves plummet.
This certainly led a good number of political analysts thinking with satisfaction: “see, it’s all politics! You cynical economists always overlooking its importance were all wrong!”
However, the effect of the political tension on prices was just temporary as they started to fall very quickly, reaching a 10-month low with Brent traded today at around 45$ a barrel. This was the result of the US shale industry coming back reinvigorated by higher prices with more oil to flood the market with.
For this year EIA predicted an increase in shale production of about 800,000 b/d, with average production at 9.3 mb/d.
Prices getting back to the downward trend must have certainly injected some life in the troops of economists with blind faith in the market, that must have thought with a smirk: “well, where is the power of politics now, my dearest political analysts?”
Between these opposite perspectives, what is the role played by the above mentioned political dynamics in influencing prices during such a critical phase of the oil market?
The GCC, Opec and its competitors
To answer this question it is useful to take a step back and look the evolving role of the Organization of Petroleum Exporting Countries.
OPEC has always been considered as having the power to balance the oil market. Being that realistic or not, when a crisis occurs everyone turns to Opec, expecting the cartel to restore market balance.
In the latest oil price shock that started in the summer of 2014 and from which prices are very far away from recovering, things seem to have changed.
Opec did not succeed in rebalancing the market, and its leader, Saudi Arabia, is not seen as the swing producer any longer. The US shale oil industry seems to have taken that role and is now the actor capable of determining the price of oil according depending on its production level.
The lack of internal cohesion shown in many cases by Opec over the last three years did not boost the trust of the market in its capacity to restore market stability, thus bringing prices down.
As a sign of change, the deal struck between several Opec and non-Opec producers last January that envisaged production cuts for all those adhering to the deal (Qatar included) was followed by a very high level of compliance, almost 100%.
Success in delivering the promised cuts, the temporary decrease in US shale oil output, the perception that Opec could still act cohesively and the ability of Saudi Arabia to play a decisive role, sustained higher prices that fluctuated for several months around 50$ a barrel.
An average price allowing higher profits revived the US shale industry, but Opec might not be capable to counter it, due to a lack of cohesiveness brought by the Gulf crisis that invested Qatar over the last month.
Tensions between Saudi Arabia, Bahrain, Egypt and the UAE on one side and Qatar on the other sparked following the Riyadh summit on 20-21 May 2017, where, according to many statements, all attending countries agreed on keeping Iran in political quarantine. Reportedly, Qatar was the only dissenting voice, with the Emir defining Iran as a force of stability.
If that was not enough, the support and the protection granted by Qatar to the Muslim Brotherhood was never seen favourably by Saudi Arabia, Egypt and the UAE, countries where the Muslim Brotherhood is blacklisted. That was stressed nn the occasion of the summit, when the attendants took the chance to agree on the necessity to counter the islamist movement.
The Beginning of the Gulf Crisis
On May the 25th, just a few days later the Ryiadh summit, that started severing relations between the Saudi-led alliance and Qatar, the 172nd Opec meeting took place in Vienna.
With the same cohesiveness showed since January, the Organization decided to extend the deal on production cuts for other nine months starting the 1st of July 2017.
Only a few days later the tensions that emerged in Ryiadh exacerbated, and the Saudi-led alliance took the decision of cutting diplomatic ties with Qatar, so recalling diplomatic representatives. But that was just the first step. Some countries ordered their citizens living in Qatar to return and Qatari citizens living in their own territory to depart. Saudi Arabia, Bahrain, Egypt and the UAE closed land, air and sea passage to all vessels and vehicles from or going to Qatar.
Considering that Qatar in maintaining good relations with Iran did not prove willing to support Saudi Arabia in its proxy wars against Iran in Yemen, Bahrain and Syria, military campaigns were not exempted from reflecting political tensions. In fact, Saudi Arabia decided to withdraw Qatari troops from the ongoing war in Yemen.
Tensions escalated to the point that on June the 23rd the countries opposing Qatar presented a list of 13 requests that had to be satisfied altogether in order to end the crisis. The requests were much beyond severing ties with Iran and the Muslim Brotherhood. On the contrary they involved many other demands, ranging from paying reparation for losses that were not even specified, to shut down the Turkish military base and Al Jazeera.
Qatar has ten days to comply with the requests and what would happen if it does not was not specified.
The requests are the attempt to strongly limit the national sovereignty of Qatar and have been described by many – and by Qatar itself – as absolutely unreasonable.
Coming back to the oil market, the first effect that this escalation could have is to jeopardize the Opec deal.
What Impact on the Oil Market?
The worst-case scenario involves military confrontation, which cannot be ruled out.
However, even excluding that possibility, depending on the magnitude of the escalation, hostilities between the Saudi-led alliance and Qatar could affect the cohesiveness among GCC member states hampering compliance with the current deal.
If Qatar aims at boycotting the deal, Iran and Iraq could decide to support it and engage in a fierce battle for market share confronting the Saudi-led alliance.
Considering that compliance with the current deal is very high and that nevertheless prices have been plummeting, the strategy in place can reveal insufficient to sustain higher prices in the long or short run. That means that future and more aggressive deals implying more consistent cuts might be necessary, but this is unlikely to happen in a climate of high political tension, given that reforms that are perceived as potentially self-harming in the short term and that are taken for the collective future prosperity need high level of cohesion to be implemented.
Opec has clearly lost much power to the shale industry, and if it wants to be effective in countering the influence of this new player it needs all the strength it is capable of.
The cartel was founded with the aim of defending the interests of a group of oil producing countries and its actions are based on consensus and cooperation among member states.
The current escalating tensions among the core of Opec – the GCC – could hinder its capacity to carry on current and future actions necessary for its survival.