Easwaran Kanason

Co - founder of NrgEdge
Last Updated: October 9, 2017
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Business Trends
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The history of OPEC and how it came to wield such power is one of two entities. On one hand, is OPEC – a coalition of the world’s largest oil producers. On the other, America, and to a lesser extent Europe, dependent on the former for energy. It worked in the 1970s, when the oil shocks proved the potency of supply restrictions. In the decades since then, OPEC has lost a lot of power. Sources of oil and gas have diversified. The USA is now on track to be a net exporter of crude and natural gas. Europe is charging towards a future that diminishes the need for hydrocarbons. And OPEC is no longer the biggest boy in town; Russia is now the world’s single largest oil producer – and has been China’s top oil supplier for several years now.

Back in 2015, as the energy industry was grappling with the aftermath of plunging prices, Russia stated that it had ‘no intention of cooperating with Saudi Arabia.’ Yet, just last week, the Saudi King Salman visited Russia. A joint US$1 billion fund was announced to invest in energy projects. In the space of two years, Russia has gone from OPEC’s main competitor to an unofficial co-president, brokering the current supply deal that has been credited for keeping oil prices stable (or at least, not plunging).

With Donald Trump’s presidency in the USA, former allies and enemies are looking to form new alliances. Even Angela Merkel was forced to admit that the EU now had to consider ‘a future without the USA.’ For Russia, the American presidency has been extremely challenging to work with, especially with the recent Congress-led sanctions. This bites down hard on Russia’s ability to do business. With the EU also threading a delicate relationship, Russia has to find new friends.

King Salman of Saudi Arabia does not do courtesy visits. His arrival in Russia – the first ever for a Saudi monarch – is a geopolitical earthquake.

It seals a strategic energy partnership that began a year ago, which has since blossomed into a new bromance – with Saudi Energy Minister Khalid al-Falih and Russian Energy Minister Alexander Novak presenting a united front. The announced US$1 billion fund is reportedly merely the ‘tip of the iceberg’, with more cooperation and joint ventures to be announced. Russia could use a lot of financial help in exploiting Arctic hydrocarbon resources – and with financial flows disrupted by American sanctions, can turn to Saudi Arabia’s deep pockets. This fits into the Saudi roadmap to expand its own infrastructure and industrial sector to diversify the economy. It also extends far beyond energy – Saudi Arabia agreed to a massive military equipment purchase from Russia, a fundamental shift in its military policy that has always sourced from the US and UK.

For Saudi Arabia, it is also an opportunity to win back power for OPEC. Cooperation with Russia is cooperation with OPEC by proxy. There are rumblings that this Saudi-Russia friendship could eventually lead to Russia becoming an official member of OPEC. It is halfway there already. The current OPEC supply freeze would not have been possible without Russian cooperation, and their help in convincing other major non-OPEC producers in Central Asia to reduce production. With the March 2018 expiry looming for the current deal, Russia is already signalling that it would like to extend the deal.

Alone, Saudi Arabia would face a challenge in this – there is a lot of conflict with other members like Iran, Iraq and Qatar. But add in Russia, and suddenly Saudi Arabia’s position becomes a whole lot more powerful, as it is able to throw its weight around like the good ol’ days in the 1970s. With US crude production rising, the main threat to Russian and Saudi oil fortunes is no longer each other, but America. A cooperation pact makes perfect sense. Which is exactly why this is now happening.

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May, 20 2022
High Oil Prices and Indonesia’s Ban on Oil Palm Exports

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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Market Outlook:

  • Crude price trading range: Brent – US$110-1113/b, WTI – US$105-110/b
  • As the war in Ukraine becomes increasingly entrenched, the pressure on global crude prices as Russian energy exports remain curtailed; OPEC+ is offering little hope to consumers of displaced Russian crude, with no indication that it is ready to drastically increase supply beyond its current gentle approach
  • In the US, the so-called NOPEC bill is moving ahead, paving the way for the US to sue the OPEC+ group under antitrust rules for market manipulation, setting up a tense next few months as international geopolitics and trade relations are re-evaluated

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