Oil: Doha Aftershocks

Published on April 18, 2016

All else being equal, things could have been a lot worse after the debacle in Doha. Oil prices are reasonably stable the morning after, supported perhaps by the Kuwaiti oil worker’s strike (since settled) while the Russian and Qatari oil ministers among others have been doing their best to limit the damage by vowing to keep talks going. Even the Iranians, who did not show up at all in the end, assert they are quite supportive of the output freeze — by the other oil producers of course.

*** We doubt, however, the oil freeze talks or any of the bullish rhetoric will mean all that much to market sentiment from here. The issue still remains Iran’s eventual participation and there is no easy resolution on that front as Iran will not back down from increasing its output as quickly as it can, and now that Saudi Arabia has publicly pushed the issue to its logical outcome, it makes a reversal by Riyadh politically difficult if not impossible or even desired at this point. ***

*** Indeed the only real driver to near term crude oil prices will be whether the Saudis follow through on the vow by Deputy Crown Prince Mohammed bin Salman that without Iran’s explicit participation in the oil output freeze, the Kingdom will feel free to increase its oil output from the current 10.2 million bpd. On balance, we understand this is not only very probable, but is effectively putting a ceiling on crude oil prices in the low to mid $40 a barrel level until there is a greater equilibrium in the supply and demand balance later this year. ***

A few other notes in the wake of the Doha debacle:

** Saudi Oil Minister Ali al-Naimi was put into a hugely uncomfortable position by mid-Sunday to reject the very compromise he and Deputy Oil Minister Abdul Aziz bin Salman – the Deputy Crown Prince’s older half brother – were working on, largely with Russian oil Minister Alexander Novak, to keep the freeze intact with the Iranians brought in “at a later date” (SGH 4/15/16, “Oil: A Contentious Doha Meeting”). The view from Riyadh, for what it is worth, was that without Iran’s agreement to at least commit to a staggered output schedule, the deal would have lacked credibility anyway. In that sense, the only part that went wrong was getting the blame put on Tehran, instead of Riyadh where it ended up.

** Nonetheless, the widely anticipated slide in oil prices may in fact be fairly slow in coming. We understand that much of the oil trades above $40 have been hedged, with many producers – in particular US shale producers – sold forward to lock in prices above $40 while many of the fixed income investors who are long did so as hedges to protect low or falling inflation positions. In addition, many of the weak hands that were long were flushed out in earlier headlines from Riyadh suddenly generating doubts about the viability of the oil output freeze.

** In the near term, we would question how long al-Naimi will remain as Oil Minister after Doha. He has been said for years to be wanting to retire, and the oil ministry has been stripped of much of its power with the transfer of Saudi Aramco and oil policy to the newly created Council of Economic and Development Affairs headed by the Deputy Crown Prince. We would not be surprised to see al-Naimi’s departure, as well as that of the long serving Deputy Oil Minister. Former head of Aramco and current Health Minister Khaled al-Falih is widely tipped to succeed al-Naimi.

** It is early days for renewed pressure on the Saudi riyal, and on that score, the question of capital outflows will depend on domestic Saudi confidence in the government and the coming economic reform plan. The Saudi Tadawul ended mostly flat on the day today, but that was only on account of what is understood to be substantial government intervention. Much more worrisome is the damage to Saudi policy credibility. An important litmus test will be how well Deputy Crown Prince Mohammed bin Salman’s radical “National Transformation Plan” is received in the weeks and months after its formal unveiling on April 25.

** The Deputy Crown Prince is the power very much behind both the more politically-tinged oil policy and the sweeping economic reforms of the NTP. While long overdue, the changes in subsidies, bringing all the Kingdom’s foreign assets under the Public Investment Fund with a more aggressive mandate to generate revenues, and changes in the way government contracts are awarded are to be implemented so swiftly and with such drastic restructurings of existing government agencies that many vested interests will be challenged, and which will be potential sources of resistance.

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