It’s been a busy few days at CERAWeek in Houston, where The Wall Street Journal has a team of editors and reporters covering the most influential annual oil conference in the U.S. Saudi Arabia’s oil minister spoke, OPEC’s secretary general broke bread with rival American producers and U.S. shale-oil companies are finally getting some recognition as a permanent fixture in the global industry.
Here’s a rundown of the major news from Houston.
SAUDI OIL MINISTER: OPEC REMAINS A STABILIZING FORCE
Saudi Arabia delivered a message at CERAWeek: Don’t expect the Saudi’s to save the oil market alone.The kingdom has shouldered the brunt of production cuts agreed to last year among the 13 nation OPEC cartel and 11 other producers, designed associated with a deal by OPEC and external oil producers to eliminate about 2% of global supply. The output deal helped send crude prices up 20%. Saudi energy minister Khalid al-Falih said OPEC will look at inventory levels in May as it evaluates whether to extend the production cut into the second half of the year. In reference to recent shale oil developments, Mr. Falih He warned an audience full of American producers who have benefited from the production cuts to not fall prey to “wishful thinking that OPEC or the kingdom will underwrite the investments of others.”
“Saudi Arabia will not allow itself to be used by others,” said Mr. Falih.
PRODUCTION CUTTERS DEFEND THEIR COMMITMENTS
Ministers from countries including Russia, Iraq and Saudi Arabia said they were following through on production-cut commitments amid signs the coalition is fraying at the edges, writes Sarah Kent. For instance, Russia has only fulfilled about a third of its pledge to reduce supply, but the country’s energy minister said Tuesday that Moscow is “fully committed” to slashing all 300,000 barrels a day it promised.
OPEC: U.S. SHALE IS HERE TO STAY
OPEC’s chief said the global economy could have been worse off without shale-oil output in the U.S., report Lynn Cook and Miguel Bustillo.
The flood of supplies from American producers over the past sent the oil market into a tailspin, but it also provided new production that was needed to meet demand, said Mohammad Barkindo, the secretary-general of OPEC at CeraWeek. “We only wish it was done in an orderly fashion that did not trigger this severe cycle that we’re still battling to come out of,” said Mr. Barkindo.
OPEC RECONCILING WITH AMERICA
OPEC’S message in Houston has been conciliatory toward U.S producers that it once counted as upstart rivals. Energy scholar Daniel Yergin, who is vice chairman of energy research at IHS Markit, told the Journal that OPEC is accepting shale producers as a major source of oil now much like it came around to the discovery of new supplies from the North Sea in the 1970s. “It’s not so much ‘us-versus-them’ any more, but a watchful but peaceful coexistence,” he said. For OPEC’s part, Mr. Barkindo said: “For the record, we didn’t have any war” with shale producers.
OPEC BREAKS BREAD WITH SHALE PRODUCERS
Mr. Barkindo took his rapprochement with shale producers to the next level, bonding with them over dinners on Sunday and Monday nights in Houston.
“Mr. Barkindo held forth about the Organization of the Petroleum Exporting Countries’ sometimes tense negotiations to hammer out an agreement to cut oil production, according to people at the meeting,” the Journal reported. “Mr. Barkindo assured shale executives that OPEC didn’t want to put them out of business. And OPEC’s top official had an admission for his audience.” “We did confess that we do not have sufficient understanding of how they operate and their impact on us,” he said later.
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Supply chains are currently in crisis. They have been for a long time now, ever since the start of the Covid-19 pandemic reshaped the way the world works. Stressed shipping networks and operational blockages – coupled with China’s insistence on a Covid-zero policy – means that cargo tanker rates are at an all-time high and that there just aren’t enough of them. McDonalds and KFCs in Asia are running out of French fries to sell, not because there aren’t enough potatoes in Idaho, but because there aren’t enough ships to deliver them to Japan or to Singapore from Los Angeles. The war in Ukraine has placed a particular emphasis on food supply chains by disrupting global wheat and sunflower oil supply chains and kicking off distressingly high levels of food price inflation across North Africa, the Middle East and Asia. It was against this backdrop that Indonesia announced a complete ban on palm oil exports. That nuclear option shocked the markets, set off a potential new supply chain crisis and has particular implications on future of crude oil pricing and biofuels in Asia.
A brief recap. Like most of Asia, Indonesia has been grappling with food price inflation as consequence of Covid-19. Like most of Asia, Indonesia has been attempting to control this through a combination of shielding its most vulnerable citizens through continued subsidies while attempting to optimise supply chains. Like most of Asia, Indonesia hasn’t been to control the market at all, because uncoordinated attempts across a wide spectrum of countries to achieve a similar level of individual protectionism is self-defeating.
Cooking oil is a major product of sensitive importance in Indonesia, and one that it is self-sufficient in as a result of its status as the world’s largest palm oil producer. So large is Indonesia in that regard that its excess palm oil production has been directed to increasingly higher biodiesel mandates, with a B40 mandate – diesel containing 40% of palm material – originally schedule for full implementation this year. But as palm oil prices started rising to all-time highs at the beginning of January, cooking oil started becoming scarcer in Indonesia. The government blamed hoarding and – wary of the Ramadan period and domestic unrest – implemented a Domestic Market Obligation on palm oil refineries, directing them to devote 20% of projected exports for domestic use. Increasingly stricter terms for the DMO continued over February and March, only for an abrupt U-turn in mid-March that removed the DMO completely. But as the war in Ukraine drove prices even further, Indonesia shocked the market by announcing an total ban on palm oil exports in late April. Chaotically, the ban was first clarified to be palm olein only (straight refining cooking oil), but then flip-flopped into a total ban of crude palm oil as well. Markets went haywire, prices jumped to historical highs and Indonesia’s trading partners reacted with alarm.
Joko Widodo has said that the ban will be indefinite until domestic cooking oil prices ‘moderate’. With the global situation as it is, ‘moderate’ is unlikely to be achieved until the end of 2022 at least, if ‘moderate’ is taken to be the previous level of palm oil prices – roughly half of current pricing. Logistically, Indonesia cannot hold out on the ban for more than two months. Only a third of Indonesia’s monthly palm oil production is consumed domestically; the rest is exported. An indefinite ban means that not only fill storage tanks up beyond capacity and estates forced to let fruit rot, but Indonesia will be missing out on crucial revenue from its crude palm oil export tax. Which is used to fund its biodiesel subsidies.
And that’s where the implications on oil come in. Indonesia’s ham-fisted attempt at protectionism has dire implications on biofuels policies in Asia. Palm oil prices within Indonesia might sink as long as surplus volumes can’t make it beyond the borders, but international palm oil prices will remain high as consuming countries pivot to producers like Malaysia, Thailand, Papua New Guinea, West Africa and Latin America. That in turn, threatens the biodiesel mandates in Thailand and Malaysia. The Thai government has already expressed concern over palm-led food price inflation and associated pressure on its (subsidised) biodiesel programme, launching efforts to mitigate the worst effects. Malaysia – which has a more direct approach to subsidised fuels – is also feeling the pinch. Thailand’s move to B10 and Malaysia’s move to B20 is now in jeopardy; in fact, Thailand has regressed its national mandate from B7 to B5. And the reason is that the differential between the bio- and the diesel portion of the biodiesel is now so disparate that subsidy regimes break down. It would be far cheaper – for the government, the tax-payers and consumers – to use straight diesel instead of biodiesel, as evidenced by Thailand’s reversal in mandates.
That, in turn, has implications on crude pricing. While OPEC+ is stubbornly sticking to its gentle approach to managing global crude supply, the stunning rebound in Asian demand has already kept the consumption side tight to match that supply. Crude prices above US$100/b are a recipe for demand destruction, and Asian economies have been preparing for this by looking at alternatives; biofuels for example. In the past four years, Indonesia has converted some of its oil refineries into biodiesel plants; in China, stricter crude import quotas are paving the way for China to clamp down on its status of a fuels exporter in favour of self-sustainability. But what happens when crude prices are high, but the prices of alternatives are higher? That is the case for palm oil now, where the gasoil-palm spread is now triple the previous average.
Part of this situation is due to market dynamics. Part of it is due to geopolitical effects. But part of it is also due to Indonesia’s knee-jerk reaction. Supply disruption at the level of a blanket ban is always seismic and kicks off a chain of unintended consequences; see the OPEC oil shocks of the 70s. Indonesia’s palm oil export ban is almost at that level. ‘Indefinite’ is a vague term and offers no consolation to markets looking for direction. Damage will be done, even if the ban lasts a month. But the longer it lasts – Indonesian general elections are due in February 2024 – the more serious the consequences could be. And the more the oil and refining industry in Asia will have to think about their preconceived notions of the future of oil in the region.
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