Oil prices have crumbled on the news over the weekend that international sanctions against Iran had been lifted, and Iranian oil tankers were already loaded and ready to go. Brent crude was trading under $28 a barrel in London on the news that Iran's deputy oil minister announced that his country would immediately begin ramping up production by 500,000 barrels a day.
While he said that Iran did not want a price war, the fact is that "sour" (high sulfur) crude like Iran's is hard to sell in the current market. A glut of high quality "sweet" crude at bargain prices mean that sour crude producers must accept even lower prices. Will an additional 500,000 barrels of Iranian crude a day be the final event to cause a capitulation among oil producers?
Throwing Fuel on the Fire
Before Iran's nuclear program sparked international sanctions, it was the second-largest oil producer in OPEC, behind only Saudi Arabia. Regaining its pre-sanction production levels of 3 million barrels of oil a day will involve refurbishing a dilapidated petroleum infrastructure. Adding 500,000 barrels a day to the 1 million bbl/day allowed under economic sanctions is seen as a more obtainable short-term goal.
The immediate aftermath of the lifting of sanctions against Iran weren't severe, as the market has known for a long time that they would soon be allowed to export oil unhindered. Analysts expect that a surge of Iranian oil (which will have to trade at a heavy discount to regain market share) will push benchmark crude prices towards $25 a barrel. That price drop and increased competition will disproportionately hit other exporters of sour crude.
Russia, Venezuela, Mexico, and Iraq are just a few exporters of sour crude that depend on exports to keep their country together. Canada's tar sands oil boom in Alberta has come undone, with Western Canadian Select selling for $15 a barrel at a break-even point of $43/bbl. Bitumen (a thick sticky substance extracted from tar sands) is selling below $10 a barrel. This is the stuff that was supposed to be transported by the Keystone XL pipeline.
Mexico's state-owned oil company was offering a $12/bbl discount on crude last month, when prices were in the mid-$30s. Now, they are only getting $12.50 a barrel. Russia uses a $50/bbl price when planning its budget. Now, with prices close to $25, the government is in dire straits. Only the South African rand has performed worse than the ruble. Venezuela has seen a near-breakdown of society, with food riots and protests over the collapse of the socialist welfare system that was supported by $80 oil.
Pain in the Shale Patch
US oil companies have also been hit heavily. It was recently reported that refiners were offering less than nothing for low-grade North Dakota crude. They want drillers to pay them 50¢ a barrel to take it off their hands! Bankruptcies in the shale patch are accelerating, In November, Haynes and Boone, LLP, a law firm specializing in the energy sector, reported 36 bankruptcies in the drilling and exploration industry. These bankruptcies left behind nearly $13 billion in secured and unsecured debt.
When Will It End?
Saudi Arabia and the other oil monarchies of the Persian Gulf have a war chest of trillions of dollars stashed away in official reserves and sovereign wealth funds. However, the quick knockout blow to US oil drillers promised by the Saudis has yet to happen, and now they are forced to cut the lavish subsidies and welfare provided their citizens. This breaks the implicit pact between the royalty and public: We coddle you, in return for you not asking for democracy.
The Saudis have said that they will not be played the fool by their competitors this time. In the early 1980s, they cut production multiple times in an effort to support oil prices, but each time, competitors just pumped more. However, the pain endured by that competition today may bring them to the table to negotiate production cuts to revive a sustainable oil price. Russia made a surprise announcement this week that it planned to cut oil exports by 6.3% (460,000 barrels a day.) The same day, Oman, who is not an OPEC member, pledged to slash oil production by 5% - 10% if OPEC did the same.
OPEC, it what may be a propaganda move, increased its estimation of how large the decline in production by non-OPEC members will be. This is another prediction of the death of the US shale industry, but if they keep repeating it, one day they may be right. But even so, advances in technology and productivity in the fracking industry means it can rapidly put capped wells back in production, as soon as prices rise. This means that oil prices are likely to never see $100 a barrel again, forcing a capitulation of high-cost oil producers, and very painful realignment for economies that were built on the back of oil exports.
The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product