This Little-Known “Export War” is the Real Reason Behind Cheap Oil
The real reason why oil prices bottomed out last week has been completely overlooked by media pundits. Yet it may be the most important factor in oil pricing today.
You see, Saudi Aramco, Saudi Arabia’s national oil company and the largest oil company in the world, is the bellwether for what all of OPEC is likely to do at any given time.
And last week, Saudi Aramco cut its prices to the Asian market significantly.
Here’s why… and what that means for oil going forward…
The Export War for Asia Continues
Saudi Aramco’s Asian price cut signals the next round in an increasingly bitter export war that will dictate broader global prices in the near term.
That’s because of two overriding considerations.
First, as I have noted here in Oil & Energy Investor on several previous occasions, Asian demand progressively dictates what is going to happen in energy markets for at least the next two decades (and probably longer, but reliable projections don’t yet exist beyond 2040).
All increases in end-user needs are centered there, with Asia and the Pacific region dictating the worldwide trends moving forward.
The international price of oil may be benchmarked by Brent (set daily in London) and WTI (West Texas Intermediate, determined in New York) but the driver is Asia’s growing appetite for energy.
And crude oil heads the list of what is being impacted…
The Saudi Oil Strategy is Working Everywhere but Asia
Second, the Saudi strategy has been to build additional export volume into the current market glut, thereby grabbing share from other producing countries. That has served its intentions adequately in other parts of the world.
But it has continued to lose ground in the primary target of Asia.
There, the primary competition continues to come from Russia and, to a lesser extent, from rising volume from both Iraq and Iran. In fact, this competition over Asia has been one of the primary reasons for the shift in OPEC policy, from cutting exports to protecting market share.
As I observed here in Oil & Energy Investor following OPEC’s 2014 “Thanksgiving Day Surprise” – the decision not to cut supply, and instead to keep pumping to protect market position – Asia had been an immediate concern even beyond the impact of US shale producers.
Now, Asia traditionally pays a premium for oil import shipments, above the price normally paid for by buyers in Europe or the U.S. Gulf Coast. The main Asian refinery complexes are also configured to use crude with a higher sulfur content (also known as “sour” crude).
As it happens, Saudi Arabia’s, Russia’s, Iraq’s, and Iran’s primary oil output is sour, setting the stage for this battle over Asia.
But in 2012, Moscow finished building the East Siberia-Pacific Ocean (ESPO) pipeline from Siberia to northeastern China. The ESPO pipeline runs a new, lower-sulfur grade crude (which Russia has proposed calling the ESPO benchmark grade).
This oil is “sweeter” (read: has lower sulfur content) than the usual Urals Blend Export coming from Russia, which is accomplished by taking out the very sour export volume from Bashkortostan and Tatarstan.
This was achieved by giving the domestic companies Bashneft and Tatneft discounts to redirect their oil supply to Russian refineries.
What this means is that, from the very beginning, the ESPO pipeline was targeting Asia with oil that not only was of better quality than that provided by the Saudis, but was being sold at prices that reduced or even eliminated the premium over Saudi oil.
The Saudi intention with the OPEC November 2014 policy shift was to drive the Asian price of oil below the level at which Russia could afford exporting ESPO oil to the continent. This is why OPEC maintained (and then increased) their oil export levels. The immediate target was Russia and Asia, not the U.S. and American shale production.
And OPEC’s strategy worked. For a while…
Russia is Rejoining the Fight for Asian Oil Exports
Initially, Russia pulled back exports to Asia followed by both the Russian economy and the ruble collapsing. In addition to combating continuing Western sanctions over its conflict with Ukraine, the Russian central budget also struggled (and continues to struggle) with lower-than-predicted proceeds from oil and natural gas exports.
That budget had initially been based on crude trading at $80 a barrel. By the time oil had moved to $30 per barrel (and below) earlier this year, the Kremlin was in panic.
Matters in Russia have now stabilized somewhat, although last week’s latest decline in crude prices has brought back some of the angst. What has changed most, however, is the attitude.
With the bulk of the damage to Russia already done, Moscow has decided to bite the bullet and rejoin the battle for the Asian oil consumer.
Realizing that the Saudi/OPEC decision to flood the oil market was meant to intensify the glut and drive Russia out, the Kremlin has decided to reply with increased exports, despite the guaranteed losses that come with doing so at current prices.
Of course, the caveat here is Moscow’s ability to sustain increased production in the face of a triple whammy: financial losses from these exports to Asia; declining extraction rates from Russia’s main oil fields in Western Siberia; and an increasingly desperate lack of both working capital and technical expertise.
But Saudi Arabia isn’t giving up yet, and has tightened the screw by reducing the price for its exports to Asia. Riyadh calculates that their advantages in very low production costs and (at least apparently) ample reserves will win out over what may be an increasingly desperate move from Russia.
Meanwhile, Asian consumers are likely to reap the benefits – lower gasoline and energy prices – from this latest game of “oil chicken.”