WUEG February 2016 Newsletter

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February 2016 to a rate still $1.25 more expensive than Iranian heavy crude. While some speculators are bracing for an increase in the crude supply glut and ruinous price competition, it is uncertain whether Iran’s tactics will be impactful and sustainable. Considering the sheer magnitude of oil production among OPEC member states, Iran’s goals to increase production will have relatively little significance in global commodity markets. In January 2016, OPEC producers maintained an output rate of 32.33 million barrels per day, with Saudi Arabia leading production. As OPEC’s fifthlargest producer, Iran simply does not have the output capacity to flood the market at a level commensurate to Saudi Arabia’s recent behavior. Iran’s domestic energy needs raise further questions about the sustainability of its oil export boost. Iran currently imports 10 million liters of gasoline daily and has frequently reduced natural gas exports to meet domestic demand. If Iran continues to depend on foreign refineries for a large portion of its consumption while exporting large quantities of crude, the country will pay more for its energy than if it kept and refined the oil at home. While cheap oil exports will clearly take their toll on the success of Iran’s energy industry, the nation’s substantial growth relative to sanction-era levels may provide sufficient impetus to continue down this path. After having its production stifled under economic sanctions, Iran will likely experience between 4 and 5.5 percent GDP growth this year in large part due to its chance to step up output. Even if Iran were to pose a serious threat to the already precarious state of global oil markets, the nation simply may not be able to maintain its cheap export prices for very long. While Saudi Arabia has been able to keep up its excessive production thanks to ample national reserves, Iran lacks such a safety net. As Iran’s reserves are depleted, the country will be forced to increase its oil export prices and let Saudi Arabia win the ongoing price war. These conflicting forces—the faulty economics of Iran’s cheap exports and the boost from an overnight increase in production—make the future of Iran’s energy industry uncertain. For the time being, the country will most likely be willing to take a financial hit if it means regaining a foothold in the global oil market, but it is uncertain how long the tradeoff will remain worthwhile. Sources: Financial Times Al Jazeera New York Times Bloomberg Saudi Arabia, Russia Meet to Discuss Production Freeze Sheetal Akole – VP, Academic Committee Saudi Arabia and Russia met in Qatar earlier this month to discuss potential cutbacks in oil production in an attempt to stabilize oil prices after they have slid over 70% in the last 18 months. The two countries reached an agreement to freeze their oil outputs at January 2016 levels. This whartonenergygroup.com 4
February 2016 agreement comes over a year after OPEC decided not to cut production to bolster faltering oil prices. After continued refusal on OPEC and Saudi Arabia’s part to react to the falling prices, the freeze hints at the dire circumstances all oilproducing nations are facing. However, the deal is conditional on the participation of other OPEC countries. So far, Qatar, Venezuela, and the UAE are among 15 countries voicing their support; Ecuador, Colombia, and Mexico are among other countries considering signing on. Iran and Iraq, holding the 3 rd and 4 th largest oil reserves in OPEC respectively, pose significant challenges to this potential solution. Markets have been expecting oil supply to continuously increase as a result of the recent repeal of sanctions against Iranian crude exports. Despite Iranian exports only growing by a third of previously stated estimates, Iran is aggressively pursuing customers, especially in the UK, and is unwilling to cut back production as they attempt to regain their market share. Iranian Oil Minister Bijan Zanganeh said that while he supports an oil production ceiling, he finds it unreasonable to expect Iran to curb its production after suffering at the hands of the sanctions for so many years. Meanwhile, still recovering from political turmoil within the state and underinvestment in the country’s oil industry, Iraq is also unwilling to freeze production. The country’s oil industry wishes to retain significant portions of its market share; especially given it is one of the main, reliable sources for government income. Some say Iraq may be persuaded to join in on the deal; if Iraq does not participate, however, it is unlikely the freeze will take place, as many other OPEC countries are also equally keen on maintaining market share and adamant that all oil-producing countries participate. Currently, willing nations account for 73% of global oil production, which to some indicates the “critical mass” required for the agreement to go through. Regardless of whether the agreement comes to a fruition considering the Iranian and Iraqi objections, market watchers continue to react to the deal with skepticism; even if the deal were to go through, it would not address the issue of the current supply glut. Countries are currently producing about 1 million barrels of surplus oil per day. This has been driven mostly by the American shale revolution, but competing OPEC countries (Saudi Arabia in particular) boosted their production in response to this in order to push out American hydraulic fracturing competition. January production was at peak or near-peak levels for both Russia and Saudi Arabia, and freezing production at this level without cutting production would do little to aid oil price recovery. Most acknowledge that the freeze deal will do little, but insist that it is a step in the right direction, and that the ‘verbal intervention’ is more likely to influence the price than the deal itself. Others believe that holding production constant amidst an environment of falling crude demand (primarily driven by the slowdown in growth in the Chinese economy) will aid in stabilizing prices in the near future. Sources: Reuters opec.org Bloomberg CNBC USNews whartonenergygroup.com 5
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WUEG February 2016 Newsletter

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