It’s been 60 years since Opec was formed by founding members Saudi Arabia, Iran, Iraq, Kuwait and Venezuela.
This episode of The Crude Report sees Argus Chief Economist, David Fyfe, take a look at what has kept the unit together and gives an update from its latest JMCC meeting.
Alejandro Barbajosa: Hello, and welcome to The Crude Report, Argus' podcast series on global crude oil markets. This is Alejandro Barbajosa, VP for business development for crude in Asia Pacific and the Middle East at Argus Media.
Opec this month celebrates 60 years from its creation in Baghdad by founding members Saudi Arabia, Iran, Iraq, Kuwait, and Venezuela – not without major challenges related to the deepest oil demand contraction in history, but also with unity of purpose and unprecedented cause by its leading members for discipline with output cuts to rebalance the market.
Today, I would like to discuss these challenges with Argus Chief Economist David Fyfe, who has 30 years of experience working in energy and commodity markets. Prior to joining Argus in April 2019, he was group chief economist for trading house Gunvor in Geneva. And before that, he was the editor of the International Energy Agency's Monthly Oil Market Report. David, welcome.
David Fyfe: Excellent, Alejandro, nice to be speaking with you again.
Alejandro: Same here. Ministers from the Opec+ Joint Ministerial Monitoring Committee (JMMC) met last week. How do you see the market challenges confronting the group Opec+ heading through the end of the year and into 2021?
David: Well, I think the JMMC identified immediately after their meeting last Thursday, that really they're focused, first and foremost on oil demand and the degree to which oil demand is recovering. Now at Argus, we think the market has regained something like two-thirds of the volume of demand that they lost in March and April. But the big question is, with resurgence of Covid-19 cases in a number of markets, what does the recovery profile look like going forward? Our view is that it's going to remain rather subdued. It could even take until 2023 or beyond before oil demand recovers to pre-Covid levels. So, this is a massive challenge to Opec and their colleagues in Opec+. They're still targeting cuts of 7.7mn b/d through the end of this year, but they raised the possibility that ministers might have to meet again in October if they see demand taking another downturn. The key point I think that the Saudi minister highlighted at the end of the meeting last week was to encourage compliance by a number of laggard producers, including some of the West African producers, Iraq, and in fact, in the most recent months, the UAE.
And I sensed a little bit of irritation on the part of the Saudi minister, both towards the non-compliers within the fold, but also towards what he called speculators in the market, who are beginning to talk down the price of crude. So, lots of short term challenges before we even get on to some of the longer-term challenges that the organization faces.
Alejandro: So, if we see all these different sets emerging, and the calls for compliance, and the lack of compliance from those members, as the organization celebrates its 60th anniversary, you know, you could say, yes, arguably the most successful international organization in the developing world. What do you think has kept it together for six decades, despite the sharp contrasts and, you know, in some cases, even political animosity between its members?
David: You're absolutely right, Alejandro. I would say in one word, the thing that has kept them together has been price, or a price aspiration. Even although Opec members sometimes paint their objectives more in terms of market stability, I think an underlying desire for a just, as they see it, a just price floor is the key driver. Now, you know, the oil space is characterized by a number of factors, you know, the relationship between fixed and operating costs, the fact that both supply and demand are relatively inelastic, and therefore it's a market that is prone to surplus. And really, for much of the last century, we've had some form of price management, whether it's been by the Texas Railroad Commission, whether it's been by the Seven Sisters, the key international oil companies, or really effectively since the 1970s it's been Opec who've been trying to moderate supply to the market and avoid periods of surplus. Now, the record has been a bit patchy. You highlighted some of the animosities between members.
But I think it's worth saying that time and time again, people have written Opec’s obituary, only for them to pull something out of the fire. I mean, it was, I think, Robert Mabro, the veteran oil market watcher, who said Opec is like a teabag, it's best when it's in hot water. And I think we've seen that time and time again, their discipline and compliance with their targets have tended to be best at times when there's been a real risk of price collapse. We saw it in 2008, 2009, and we saw it eventually, again, in the early part of 2020, when after flooding the market in March and April, they actually pulled back and stitched together a very ambitious deal with their colleagues in what is now called the Opec+ grouping.
Alejandro: Actually, since you mentioned those two landmarks, those two dates, there's a point in between that I'd like to highlight. And that's basically the end of 2016 when they completely turned around in terms of their market share strategy and started trying to rebalance the market again. And since then, the issue of overproduction and compliance has been dealt with with seemingly added determination. Opec has also, as you said, enlisted the help of key non-Opec members like Russia, and nine other producers to create the Opec+ agreement. How durable do you think this accord will be? And will Saudi Arabia as passive Opec leader want to institutionalize this arrangement in the longer term?
David: You hit the nail on the head there, because I think from Saudi Arabia's perspective, and maybe a number of its allies in the Gulf, they probably would like to lock in producers like Mexico, Russia, the Central Asian producers, and so on. They're even, you know, talking also to countries like Brazil. So, I think they would certainly like to institutionalize this arrangement. I think the big question is, how keen is a producer like Russia, to stick with this program for the longer term? I mean, what they have put together since April 2020 has been almost unprecedented cuts of initially 10mn b/d, currently, near as down at 8mn b/d, and then 6mn b/d running through 2021 and as far as April 2022. Almost unprecedented in terms of duration, extent of the cuts that they're talking about. So, there's a massive amount of questions about whether they can stay the course.
I would say the GCC producers, yes, would probably like this deal to be durable. Whether the Russians, the Mexicans and others are prepared to stick with this sort of restraint over the next 18 months, 2 years, I think is very much open to question.
Alejandro: The circumstances under which this agreement came into shape were extraordinary. And not only in terms of the volumes was agreed, but in terms of who participated and who actually seemingly brought together the key participants in the deal. So, I think we can speak about a change in Opec’s perception in the US over the past decade, especially following North America's shale miracle. Is the US likely to keep a favorable view of Opec, should we see a change of administration next January?
David: I think that's a great question. And I do think that we saw a fundamental change back in April. I mean, President Trump has, in the past been on record, criticizing Opec attempts to withhold supply to the market. The pump price of gasoline has for decades been a key political touchstone, if you like, and therefore any suggestion that outside influence might be boosting the price of crude has traditionally been regarded rather negatively by the US. But I think in light of the exceptional collapse, industrial collapse that we've seen in the light of the pandemic which has affected the auto industry, the airline industry, and potentially risked undermining the US shale revolution altogether if prices had remained in low double digits, or even, heaven forbid, single digits, I think that caused a bit of a change of heart on the part of the Trump administration, and a number of other G20 governments. And they actually helped to stitch together the Opec+ deal.
So, I suspect it may be rather more difficult in the months ahead for the US to suddenly go back to criticizing what Opec and its colleagues would say is an attempt to try and stabilize the market. I think what will be very interesting is to see how attitudes towards Opec change if we get a change of administration in the US. We might have a Biden presidency which could be rather more accommodative towards Iran, so you raise the possibility of incremental Iranian barrels re-entering the market, sometime from 2021 onwards. And of course, that would potentially cause some greater tensions within Opec+, particularly between Iran and the Saudis. Although it has to be said that historically, the Iranians and the Saudis have managed to put their differences in the broader political sphere behind them when it comes to market management in the oil space. So, it's going to be incredibly interesting to see how that pans out over 2021 in the aftermath of the election in the US.
But I think, I mean, what you're raising there is something I'd like to throw back to you, Alejandro, because ultimately, I think it'll all be about price, you know, market stability, and avoiding a surge in prices in the future. And I think if that happens, then the US probably will be relatively forgiving of Opec going forward. But you spend a lot of time talking with not only the Opec national oil companies from the Middle East, but also Asian importers of crude and let's remember, Asia buys 70pc of Opec’s crude exports. What are you seeing in terms of the way those Opec NOC's are looking at the market? And what are they thinking about in terms of pricing and pricing going forward?
Alejandro: Well, the interaction of US crude with Middle Eastern crude in the Asian market is really setting the price of the marginal barrel. So, I think that, you know, the national oil companies in the Middle East are becoming a lot more sensitive to the pricing of US crude in the region, not only on an FOB basis but also on a delivery basis, because that's the best way to integrate and to be able to compare the prices. So, that's why Argus publishes a price for WTI delivered to Northeast Asia and also prices for Middle Eastern grades delivered to that region to see how for example, WTI competes with Murban in that market for market share, basically. And what is key going forward is that the Asian market participants will be paying more and more attention to that price of US crude and in particular, the price of US crude as is priced at the Gulf coast. And for that purpose, Argus is now publishing what is a generic price that comprises not only the domestic liquidity of the pipeline market, but also the exported cargoes that are loaded at the US Gulf coast, which is virtually the most liquid pricing mechanism of a physical nature for physical crude in the world called Argus AGS, American Gulf Coast Select.
So, the national oil companies in the Middle East are now tracking these new pricing mechanisms. At the same time, they try to renovate and modify the way that they've been pricing their crude for decades to become more sensitive to the pricing of that WTI. So, that is how we expect that US crude in terms of pricing will be a lot more important and central to the competitiveness of Middle Eastern grades into the Asian market.
And I think we're about to run out of time, David. So with that, I would like to thank you very much for your time, unless you'd like to add anything to close up.David: Only to say I agree with you. I mean, we haven't seen the end of the US shale growth story. We think probably US upstream consolidation is underway and it's being accelerated by the price fall we've seen recently. But there's gonna be more U.S crude exports, albeit growing more slowly coming out of the U.S. Gulf Coast. So, I think it's a great place to finish our discussion to highlight the importance of good price benchmarks such as AGS, to help price those barrels into the importing markets.
So, thanks for asking a lot of very testing questions today. It's been great talking to you, Alejandro.
Alejandro: It's always a pleasure as well, David. Thanks for sharing all that wealth of experience with us. And for more in-depth analysis and independent coverage of global crude oil market derivatives, arbitrage market fundamentals, and global trading, consider subscribing to Argus Global Markets. You can find more information on this service at www.argusmedia.com. Thanks for tuning in, and we look forward to you joining us on the next episode of The Crude Report.