The Effect Of Falling Oil Prices On Russia, Saudi Arabia, Oil Producers

As of June 25, Brent and WTI grade crudes continue to show weaker price trends despite one or two previously sure-and-certain price tweakers towards the upside, that no longer work today. In fact, the biggest should-be tweaker, tropical storm Debby, itself shows how fundamentals are stacking up and driving down oil prices. When prices attain about $75 per barrel for WTI, and more for Brent, this will draw squeals, threats, promises and posing from Saudi Arabia and Russia.
 
Hurricane Debby has played havoc in the Gulf of Mexico and shut down about a quarter of oil and gas output capacity in the GoM but this isn't what it used to be. In 2005, offshore supply from the GoM accounted for about 30% of US oil production and 17% of natural gas production. Now it only accounts for 20% of US oil production and an unimpressive, and declining 6% of US natural gas production.
 
Production has migrated back onshore, thanks to shale gas and shale oil, making US output much less exposed to weather risk, especially Caribbean tropical storms. Under today's conditions, US oil and gas supply are more than ample with crude supply near a 22-year high and natural gas supply at a record for this time of the year when demand tends to be low, and will only rebound if there is a weather shift to high summer heat. The US dollar is also strengthening and could sprout wings (at least for a short period) if European cliffhanging and flirting with the abyss moves to free-fall and to real world breakdown of the Eurozone: with a stronger dollar, oil prices should be weaker.
 
Oil prices have now fallen for about two months, with Brent crude sinking through several supposed "resistance/support levels" to around US$90.10 a barrel, compared with US$119.57 on May 1, and West Texas Intermediate at about US$79.10 today, falling from US$106.17 on May 1
 
To be sure, the famous "Brent premium" hangs on and hangs in, but so many fundamentals run against that antique hand-me-down of the oil trading fraternity, that its life expectancy is low: nothing prevents the premium being squeezed to a symbolic $5 in a relatively short timespan ahead. The basic explanation is simple: since Q1 2012 the world has been producing more oil while global oil demand is for the most or best set in a mould of very close to zero growth, or perhaps decline.

The arguments for straight decline are rising, almost exactly tracking the decline of oil prices. According to the Energy Intelligence Group, global demand showed no recovery at all from daily demand levels of November-December 2011. Possible short-term and fragile recovery in global demand, early in Q1 2012 - which was used by the oil trading fraternity to talk prices above $125 per barrel for Brent - has surely disappeared off the radar screen
 
Global oil demand may have attained 90.5 million barrels per day (Mbd) early in the year, but since late April, as now recognized by the IEA, the track of decline is sure and certain. Current global demand may be less than 88.5 Mbd. At the same time, global conventional gas finds, some of it with probably appreciable condensate yield potentials, have been massive since late 2011, and the OPEC group, and Russia, are producing oil at high, or sometimes record rates. Year on year, OPEC's output has grown 10 percent during the past 12 months.
 
THE NEW DAWN FOR GLOBAL OIL
Totally unlike the 2008-2009 sequence of oil price crash and then rebound, which had almost zero relation to demand/supply changes and was a "purely financial event", the last time that global oil supply outstripped demand was in 2006. Compressing the price facts to where we need them, oil prices started 2006 at around US$60 per barrel and ended the year at US$60 per barrel.
 
An overquick conclusion from this says that oil prices, today, could be headed for $60.
 
It however sets the real panic-price level for Saudi Arabia and Russia, and identifies why they will take avoiding action much further up the price scale: from US$75 per barrel. Especially for Russia, where OAO Gazprom is beginning to map the contours of its coming decline - rather than looking at the future, not liking it, and saying it doesn't exist -  falling oil prices and falling gas prices can deliver a hard blow to the Putin Empire. This could possibly be to the extent of "tweaking" the tail of the Russian bear by one turn too much, making it especially aggressive.
 
Saudi Arabia's oil price sensitivity, claimed by Saudi braggers to be so low it doesn't exist, has climbed so high and far from the long-dead days of Saudi claims that it can live with oil at $35, that figures near US$60 or even 70 per barrel can be taken seriously. Plenty of other OPEC states, measuring their oil price sensitivity relative to their national budgets, debt servicing, and oil sector development financing, are right up at the $75 plimsoll line. Facing the producers however, the world's biggest oil consumer, the US is now sitting on more oil supplies than it has had since 1990. This coincides with the US having its weakest oil demand for 15 years - and at most only fractional growth prospects. Other OECD oil consumers are using ever less oil, especially the European group which is showing its sixth year of oil demand contraction at a 6-year average rate of 2.5% each year.
 
To be sure this is powerfully driven by recession, but is also aided by growing energy efficiency and accelerating changes in the energy economy, shown by the ever growing GDP output from each barrel that is spent or used.
 
Another acid test for "the right price" of oil is coming from the trader community itself: in highly predictable fashion, the slump in oil prices has coincided with a steep selloff in oil futures contracts over the last three months. According to the US market watchdog agency the CFTC (Commodity Futures Trading Commission) speculators have cut their net-long positions—their bets that the price will rise—to the equivalent of 136 million barrels of oil, the lowest since September 2010, and the exact opposite to the vast binge of speculative buying that preceded.
 
At the time, things were good for net-long speculators: there was still some mileage in the Iran nuclear crisis, despite its antique status, but above all global oil demand seemed to be recovering. The result was a six-month bull run that is now history. With the speculators out of the market, prices will tend to more easily reflect supply-demand fundamentals, not a screen shot from Goldman Sach's trading programs, with the near certain readout that oil prices can or should decline all through summer.
 
That however depends on how fast and how far prices fall this summer.
 
SAUDI AND RUSSIAN REARGUARD ACTION
Current price trends are already running faster than market analysts and gurus cared to imagine, with many of their forecasts still set at Brent prices softening to around US$90 per barrel by September, and  West Texas Intermediate possibly falling to as low as US$80 by the same date. Saudi and Russian reaction will therefore tend to be jumpstarted by prices softening faster than predicted.
 
The unlikely alliance and unholy (or uncoranic) couple of Russia and KSA will almost certainly and quite rapidly be squealing. Their fears are easy to understand: nothing particularly prevents oil prices slumping to US$60 per barrel - consumers would find no special problems in accepting oil at that price, even if the economic benefits of cheap oil have been drastically exaggerated for decades. Cheap oil is in fact a producer problem, not a consumer problem, and both of the strange couple have problems.
 
Of the two biggest producers, Russia has the largest problems accepting prices much below $75 per barrel and staying there. A big cut in its oil revenues at a time when gas prices are under sure and certain threat - if a couple of years ahead - and commodity prices outside the energy sector are set to decline, spells big trouble for Russia's national finances, the economy, and Putin's now troubled and contested leadership. For Russia, a Middle East conflagration of the type that his favourite local dictator, Bashr el Assad is threatening would be a welcome oil price booster. Defending el Assad will be an interesting test for Putin: if he lets the war criminal drop, oil prices will soften even further.
 
More discreet but at least as worried as the world's producer countries, we have big energy: all the so-called "oil majors" are now engaged in an historic gas shift away from oil, producing more gas energy and building more energy reserves as gas, than oil. But financing this shift needs oil prices which stay firm and relatively high. Key examples concern the financing of mega projects like the Gazprom-Total-Statoil majority gas project in Russia, the Shtockman project whose fate now hangs in the balance. Without oil prices around $75, this project is likely to be abandoned or shifted far forward in time.
 
Right behind the Russian and Saudi moves that are predictable when WTI prices hit US$75 a barrel and before Brent prices fall to the same level, big energy corporations will also be moving to stem the price rout. Their action may take many forms but underlining how $75 oil is now "cheap", their financial performance and stock price will be heavily damaged at these prices levels, today in 2012. Below $60 really hard times are in view for these ex-oil majors making a financially perilous but abudant resource-driven shift to gas, with several predictable signs of the process.