The history of OPEC – the cartel, of some of the world’s largest crude oil producers, has been one of historic co-operation or divergence. When OPEC acts in concert, it can awe the world in either direction; see the terrifying oil shocks of the 1970s or the unprecedented 2020 deal that removed nearly 10 mmb/d of supply to stabilise the market in response to Covid. The addition of Russia and other countries into the broader OPEC+ club bolstered the firepower of the group, but also ratcheted up the tensions within. Because when OPEC fails to agree, the results can also be spectacular, leading to unfettered production and devastating price wars. Typically, the instigators of a showdown tends to be Saudi Arabia (or Russia in OPEC+), or one of the more recalcitrant members like Iran, Iraq or Nigeria. But the latest rupture has come from an unlikely quarter. The previously pliant United Arab Emirates is now holding up OPEC+’s path forward as an unlikely source of drama.
It was supposed to have been easy. After several months of routine meetings followed more routine approval of cautious monthly eases of the group’s supply quotas, the July OPEC+ meeting was expected to be more of the same. Resurgent demand amid economic re-openings and accelerating vaccinations dampening the potency of new Covid-19 variants saw oil supply/demand balances tighten. OPEC+ discipline was key to this, allowing crude oil benchmark to rise to their highest levels in nearly 3 years, with US$70/b being a sweet spot that satisfies domestic budgets and consumption concerns. Ahead of the July 1 OPEC+ meeting, the ministerial panel had recommended that the group adds 400,000 b/d in volumes every month from August to December, and that the wider agreement itself should be extended in full to December 2022 (from its original end date of April 2022). This would be more cautious than required by the market but, the OPEC+ ministers argued, was necessary in case Covid resurgences turned into another series of devastating waves.
The loggerheads over the recommendations was always expected to be between Saudi Arabia and Russia: the former representing the voice of caution and a need for discipline, while the latter argues that additional barrels can still be absorbed by the market as it attempts to flex its production prowess. But, as is turns out, all members of OPEC+ had reportedly signed up to the new recommendation. All except one.
The history of the UAE in OPEC is one of alliances. Along with Kuwait, the UAE has always been #TeamSaudi within the club, supporting the kingpin across the various heated discussions and decisions. In the realm of geopolitics, Saudi Arabia and the UAE are staunch allies. They did, after all, engineer a remarkable blockade of Qatar for nearly 4 years in response to alleged support of terrorism through links with Iran. But the strength of alliances ebb and flow. And in January this year, the break between the two allies was starting to show.
Key behind this is the UAE’s grievance that it had been handed an unfair baseline – the level which all OPEC+ countries are expected to measure their production cuts or increases against. The current level for the UAE is 3.2 mmb/d, and it argues that this should be raised to 3.8 mmb/d if it is to endorse any extension. And the logic behind that is the UAE has been investing heavily in output expansions and is itching to capitalise on that, particularly since it wants extra liquidity to boost its attempt to convert its Murban crude futures contract into a regional crude benchmark. Both Saudi Arabia and Russia have rejected the argument for re-calculating the output target, fearing that everyone else in OPEC+ will ask for the same treatment. This impasse – which is essentially UAE vs everyone else – could potentially unravel the deal that took several weeks of intense negotiation and the assistance of the White House to broker.
In the absence of a new deal, there is a fallback deal. And that is to maintain supply levels at July levels for the rest of the year. But that itself is a risk, since global oil supply is lagging behind demand, and the inflationary effects of elevated crude oil prices are starting to show. Keeping production flat – assuming there are no breaches of compliance – risks further price spikes, and other producers rushing in to fill the gap at the expense of OPEC+ market share. Which is the last thing OPEC+ wants, especially is the rush is from US shale producers.
But an even more dramatic scenario could see a full-scale rebellion of the UAE against its quotas and potentially its exit from the cartel, a possibility strategically ‘leaked’ to reporters back in January. This would break OPEC+ unity, risking a free-for-all situation that could crash prices is other producers follow suit and trigger a punishing price war. In a show of just how close this nightmare scenario is, Saudi Energy Minister Prince Abdulaziz bin Salman has publicly stated that he has not spoken to his counterpart in Abu Dhabi as the July 1 meeting stretched further and further with all parties attempting to come to a compromise. And a compromise is still the most likely resolution, since it is against all interests to jeopardise the stabilised crude oil situation with a price war now. The most likely result is that – after plenty of sound and fury – OPEC+ will endorsed the supply increases for August to December, but not extend the duration of the deal beyond April 2022.
How long and deep will this chasm grow between Saudi Arabia and the UAE? How will this fundamentally reshape the politics within OPEC+? On all evidence right now, it seems like it could be quite a while. Because this is bigger than just oil. Riyadh and Abu Dhabi have been on a crash course for a while now. The UAE has been developing its own foreign policy themes, which are increasingly independent of its Saudi ally – see its recognition of Israel and its position on Yemen. Saudi Arabia’s call for international firms operating in the Middle East to move their regional headquarters to Riyadh has also been interpreted as a threat to Dubai. And in a chilling reminder of the Qatar blockade, travel between the two countries has been restricted. The healing of this rift will be key, not just to the future of OPEC+ but the incendiary geopolitical dynamics of the regions, especially with the incoming return of Iran from the cold to the oil markets and the wider world. OPEC+ has just experienced an earthquake, and now it is time to see what the aftershocks are going to be.
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International expansions for Saudi Aramco – the largest oil company in the world – are not uncommon. But up to this point, those expansions have followed a certain logic: to create entrenched demand for Saudi crude in the world’s largest consuming markets. But Saudi champion’s latest expansion move defies, or perhaps, changes that logic, as Aramco returns to Europe. And not just any part of Europe, but Eastern Europe – an area of the world dominated by Russia – as Saudi Aramco acquires downstream assets from Poland’s PKN Orlen and signs quite a significant crude supply deal. How is this important? Let us examine.
First, the deal itself and its history. As part of the current Polish government’s plan to strengthen its national ‘crown jewels’ in line with its more nationalistic stance, state energy firm PKN Orlen announced plans to purchase its fellow Polish rival (and also state-owned) Grupa Lotos. The outright purchase fell afoul of EU anti-competition rules, which meant that PKN Orlen had to divest some Lotos assets in order to win approval of the deal. Some of the Lotos assets – including 417 fuel stations – are being sold to Hungary’s MOL, which will also sign a long-term fuel supply agreement with PKN Orlen for the newly-acquired sites, while PKN Orlen will gain fuel retail assets in Hungary and Slovakia as part of the deal. But, more interestingly, PKN Orlen has chosen to sell a 30% stake in the Lotos Gdansk refinery in Poland (with a crude processing capacity of 210,000 bd) to Saudi Aramco, alongside a stake in a fuel logistic subsidiary and jet fuel joint venture supply arrangement between Lotos and BP. In return, PKN Orlen will also sign a long-term contract to purchase between 200,000-337,000 b/d of crude from Aramco, which is an addition to the current contract for 100,000 b/d of Saudi crude that already exists. At a maximum, that figure will cover more than half of Poland’s crude oil requirements, but PKN Orlen has also said that it plans to direct some of that new supply to several of its other refineries elsewhere in Lithuania and the Czech Republic.
For Saudi Aramco, this is very interesting. While Aramco has always been a presence in Europe as a major crude supplier, its expansion plans over the past decade have been focused elsewhere. In the US, where it acquired full ownership of the Motiva joint venture from Shell in 2017. In doing so, it acquired control of Port Arthur, the largest refinery in North America, and has been on a petrochemicals-focused expansion since. In Asia, where Aramco has been busy creating significant nodes for its crude – in China, in India and in Malaysia (to serve the Southeast Asia and facilitate trade). And at home, where the focus has on expanding refining and petrochemical capacity, and strengthen its natural gas position. So this expansion in Europe – a mature market with a low ceiling for growth, even in Eastern Europe, is interesting. Why Poland, and not East or southern Africa? The answer seems fairly obvious: Russia.
The current era of relatively peaceful cooperation between Saudi Arabia and Russia in the oil sphere is recent. Very recent. It was not too long ago that Saudi Arabia and Russia were locked in a crude price war, which had devastating consequences, and ultimately led to the détente through OPEC+ that presaged an unprecedented supply control deal. That was through necessity, as the world faced the far ranging impact of the Covid-19 pandemic. But remove that lens of cooperation, and Saudi Arabia and Russia are actual rivals. With the current supply easing strategy through OPEC+ gradually coming to an end, this could remove the need for the that club (by say 2H 2022). And with Russia not being part of OPEC itself – where Saudi Arabia is the kingpin – cooperation is no longer necessary once the world returns to normality.
So the Polish deal is canny. In a statement, Aramco stated that ‘the investments will widen (our) presence in the European downstream sector and further expand (our) crude imports into Poland, which aligns with PKN Orlen’s strategy of diversifying its energy supplies’. Which hints at the other geopolitical aspect in play. Europe’s major reliance on Russia for its crude and natural gas has been a minefield – see the recent price chaos in the European natural gas markets – and countries that were formally under the Soviet sphere of influence have been trying to wean themselves off reliance from a politically unpredictable neighbour. Poland’s current disillusion with EU membership (at least from the ruling party) are well-documented, but its entanglement with Russia is existential. The Cold War is not more than 30 years gone.
For Saudi Aramco, the move aligns with its desire to optimise export sales from its Red Sea-facing terminals Yanbu, Jeddah, Shuqaiq and Rabigh, which have closer access to Europe through the Suez Canal. It is for the same reason that Aramco’s trading subsidiary ATC recently signed a deal with German refiner/trader Klesch Group for a 3-year supply of 110,000 b/d crude. It would seem that Saudi Arabia is anticipating an eventual end to the OPEC+ era of cooperative and a return to rivalry. And in a rivalry, that means having to make power moves. The PKN Orlen deal is a power move, since it brings Aramco squarely in Russia’s backyard, directly displacing Russian market share. Not just in Poland, but in other markets as well. And with a geopolitical situation that is fragile – see the recent tensions about Russian military build-up at the Ukrainian borders – that plays into Aramco’s hands. European sales make up only a fraction of the daily flotilla of Saudi crude to enters international markets, but even though European consumption is in structural decline, there are still volumes required.
How will Russia react? Politically, it is on the backfoot, but its entrenched positions in Europe allows it to hold plenty of sway. European reservations about the Putin administration and climate change goals do not detract from commercial reality that Europe needs energy now. The debate of the Nord Stream 2 pipeline is proof of that. Russian crude freed up from being directed to Eastern Europe means a surplus to sell elsewhere. Which means that Russia will be looking at deals with other countries and refiners, possibly in markets with Aramco is dominant. That level of tension won’t be seen for a while – these deals takes months and years to complete – but we can certainly expect that agitation to be reflected in upcoming OPEC+ discussions. The club recently endorsed another expected 400,000 b/d of supply easing for January. Reading the tea leaves – of which the PKN Orlen is one – makes it sound like there will not be much more cooperation beyond April, once the supply deal is anticipated to end.
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- Crude price trading range: Brent – US$86-88/b, WTI – US$84-86/b
- Crude oil benchmarks globally continue their gain streak for a fifth week, as the market bounces back from the lows seen in early December as the threat of the Omicron virus variant fades and signs point to tightening balances on strong consumption
- This could set the stage for US$100/b oil by midyear – as predicted by several key analysts – as consumption rebounds ahead of summer travel and OPEC+ remains locked into its gradual consumption easing schedule
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