Baku, Azerbaijan, June 8
By Dalga Khatinoglu
In the aftermath of the recent OPEC meeting in Vienna, which kept the production ceiling unchanged at 30 million barrel per day, Trend asked former director of the International Petroleum Exchange and market expert Chris Cook for his views on the outcome.
Mr Cook, there appeared to be no shocks at this OPEC meeting and Saudi oil minister Mr al-Naimi declared himself as 'comfortable' with whatever may happen in the future. What's your view?
"Indeed, OPEC appeared as calm as a swan on water, but I assure you that there was a great deal of paddling going on under the surface! Friday's OPEC meeting was once again a pretty meaningless sham, but there were dialogues which were taking place before and around the meeting of great significance".
"The first key dialogues were those between Iran's oil minister Bijan Zanganeh and the assembled top management of almost all of the major International Oil Companies (IOCs) who are not typically to be found around OPEC meetings in such numbers. The second was the presence of major non-OPEC producers such as Russia and the dialogue between them and OPEC producers."
"Perhaps the only significant official contribution came from Mr El Badri the OPEC secretary, when he said that he did not expect Iranian oil to reappear imminently on the market. I am sure that this was noted with interest by Iran."
Tell me about the IOC's. Why were they present in Vienna in such numbers?
"Big Oil is being squeezed between an immovable object and an irresistible force. The immovable object is an upper limit or boundary price, probably between $60 and $70/barrel, at which a combination of high cost US shale oil production; falling renewable energy costs; and demand reduction through energy efficiency, combine to limit oil price increases for any length of time. The irresistible force is the inexorable rise in exploration and production costs as finite cheap to produce oil is exhausted."
"IOCs have four courses of action available to them: they can merge to achieve economies of scale, which may give temporary relief; they can switch to natural gas as Shell has done; they may change their business models to become service providers (which is already beginning to occur with smaller players); or they may compete for access to the last remaining low cost oil & gas reserves - which is what has taken IOCs to Vienna, and to a dialogue with Mr Zanganeh in respect of the intractable problem of finding contractual terms which are acceptable both to Iran and to IOC shareholders."
"Low cost Saudi Arabian oil fields on the other hand are mature and essentially in run off mode, with little scope for development profits for IOCs. On the other hand, Iran and Iraq (where no development takes place without Iran's implicit support or consent) are pretty much the sole remaining source of massive reserves of low cost oil. So with Iranian sanctions on the way out, it's open season in Iran for Big Oil".
What about the presence of non-OPEC nations in Vienna?
"Had the oil price remained at $45/barrel, which it reached in January after the last OPEC meeting, then I suspect there would have been an accommodation between OPEC and non-OPEC producers to share the pain through coordinated production cuts. But since the oil price has now risen to over $65/barrel and both Saudi Arabia and Russia are therefore receiving an additional $200m per day, that discussion has not been necessary. However, I think that there are an increasing number of issues of common interest between OPEC and non-OPEC producers which merited dialogue."
I have a question for you as to the oil price, Mr Cook. While many market participants say that the oil market is heavily over-supplied - not least because they believe the Saudis are producing flat out to maintain market share - the price rose by $20/barrel very rapidly indeed. Is there not a contradiction here?
"That is a very astute observation and question. The Brent/BFOE North Sea crude oil global pricing platform has been owned and controlled by IOCs and investment banks since inception. But any market participant with adequate capital funding and access to bank liquidity may use the platform to support the oil price. While OPEC members collectively have never undertaken such market support action it is open to individual OPEC members to do so if they wish."
"In my view, since January 2015 billions of dollars of Saudi financial reserve assets have been switched into the oil market with the effect of increasing the market price from $45 to $65/barrel. This was achieved firstly through prepay (purchase & resale) investment via banks in inventories of stored oil, and secondly through support of the Brent Oil price as stated above."
"So in other words, current flat out Saudi crude oil production has nothing whatever to do with maintaining market share as they claim, and everything to do with repaying as quickly as possible what is essentially an 'oil loan' by other market participants."
I recall that you wrote previously in Trend that the oil price which collapsed late last year took place as you had said in 2012 it would when the US quantitative easing (QE) which fuelled an artificial oil price bubble came to an end. But since the US Federal Reserve Bank has not resumed dollar QE, who then is providing the market with liquidity?
"That is the most fascinating aspect. Shale oil has enabled the US to displace the Saudis as the marginal or swing producer at high oil price levels. So the US has attained energy security through creating what is essentially a second tier Strategic Petroleum Reserve of high cost shale oil. In other words, whenever oil prices increase sufficiently the US may cap the market price by bringing shale oil production back to market. In my view, the US imposed through market manipulation what was essentially a stealth tax on US consumers - and thereby achieved the energy security which enabled them to terminate a 70 year relationship with the Saudis which has increasingly become an embarrassment."
"Now, while this represents in my view the most significant oil market development since the 1973 Oil Shock, it is a coin with two sides. Through the decades since 1973 the Saudis have deposited dollar proceeds of oil sales in dollar denominated investments and bonds, and thereby created what became known as the Petrodollar. In my view, now that their geopolitical understanding or agreement with the US is over, the Saudis have now begun to switch their financial reserves to Euro financial assets, and the current oil market price bubble is therefore fuelled with Euros created by Quantitative Easing from the European Central Bank."
If it is true that the era of Petrodollars is over, it would represent a very significant development in global financial markets. What evidence do you have to support that contention?
"There are several - necessarily circumstantial - data points, and I will try to avoid the most technical of them. Firstly, the rapid rise in oil prices - which was completely unrelated to any fundamental physical market event - began immediately after the announcement by the ECB of their QE programme in mid January 2015. Secondly, the Brent North Sea oil price, and the price of German government debt (the Bund - widely prized by investors) have become over 92% correlated. Third, the ECB's QE program has been recently 'front loaded' - that is to say that large amounts of Euro creation by the ECB have been brought forward presumably to meet demand from the Saudis for the Euros necessary to purchase € denominated securities like the Bund.
Leaving the US and Saudis to one side, what is the position of Azerbaijan's neighbors, Iran and Russia, at the moment?
"Not only do Iran and Russia have enormous oil production capacity, they also between them possess approaching half the global natural gas reserves. It seems to me that the global oil market is in crisis. On the one hand OPEC is clinically dead, and on life support, having become an instrument of Saudi manipulation. On the other hand the North Sea Brent/BFOE crude oil pricing complex is also clinically dead and on life support, having become a plaything of a handful of IOCs and investment banks.
In my view, since existing oil market institutions have failed or are failing, Iran and Russia may be well advised to operate outside the existing oil market institutions through the simple expedient of energy swaps, similar to those pioneered by Iran in the Caspian region.
By way of example, Iran could supply (say) crude oil to Greece (as Iran did in the recent past when no-one else would) in exchange for a share of the flow of refined products i.e.: an oil for product swap. Or Russia could supply natural gas in exchange for Azeri power from new and more efficient generation capacity - a gas to power swap.
In this way, we will see a transition from the conventional market paradigm of oil and gas sold as a commodity via middlemen to a market paradigm of energy supplied as a service directly by producers to consumers and facilitated by service providers."
"That is an interesting vision. What would it take to implement it?"
"Simply put, agreement with consumers, and the use of energy credit instruments. The concept of an international natural gas clearing union has been around for a while, and an Iranian colleague of mine long since proposed that Iran, Russia and China might act as founders of such a union - a G3 - with the Caspian region becoming the global gas price reference point or benchmark."
"So perhaps instead of oil being priced in dollars (or even euros) and gas then being priced against oil as now, we may then come to see oil, dollars and euros all priced against gas?"
Thank you once again for your insights and ideas, Mr Cook.
Edited by CN
Dalga Khatinoglu is an expert on Iran's energy sector, head of Trend Agency's Iran news service
Follow him on @dalgakhatinoglu