While political events like the EU Referendum result and the election of Donald Trump in the US presidential elections have drawn a lot of attention from the media and have both affected the global economy, other events have also had a significant effect on the oil and gas industry.
In this article, our co-founder and commercial director, Andre Davis, outlines how events in Saudi Arabia could kick off a new oil war.
This year has seen some seismic political events take place. The kind that can have a serious effect on the world as a whole. However, significant events have also taken place in the oil industry this year that could end up having a seismic effect on the world as a whole too.
Firstly, to briefly tackle those seismic political events – The majority of the British electorate voting for Brexit and the Electoral College voting Donald Trump as the next President of the United States - any change creates potential uncertainty in the markets, and you could sense as The EU Referendum vote approached that businesses had started to become reticent and markets were beginning to flitter nervously. This was because there was such uncertainty over what the outcome would be in the run-up, and this is not conducive for business of any kind. The tone of the Presidential race across the Atlantic, along with the uncertainty of what that result would be given Mrs Clinton and Mr Trump were two of the most unpopular Presidential nominees ever, served to compound the problem, and I certainly noticed earlier this year that any speculative projects and major investments my clients were considering were put on hold, with them instead concentrating on completing essential works, maintenance and repairs.
However, I would argue the most significant event to affect the oil and gas industry this year has been the opening salvos of a new oil price war caused by the boom in America’s fracking industry.
Due to the expansion of fracking in the United States in the last few years, America became the No.1 producer of oil worldwide almost overnight. This caused Saudi Arabia to respond in two ways. The first and most important way was to oversupply the market through Saudi-controlled OPEC. This was designed to drive down the oil price from a high of $140 per barrel and drive US frackers, who often need at least $60 per barrel just to break even, out of business.
In addition to frackers in the USA, the low oil price affected everybody around the world, particularly the smaller producing countries who are almost 100% reliant upon oil for their Gross Domestic Product (GDP) revenue.
As a result, oil prices had to rise, and I would argue this was one of the main drivers behind the various announcements by the Organisation of the Petroleum Exporting Countries (OPEC) and Russia agreeing to decrease production in order to raise prices per barrel levels recently.
The most recent announcement was just last week. These represent the first official production cuts since the global recession of 2008. I would say the agreement is unprecedented in nature too because it has allowed Iran, Iraq and Nigeria to be exempt from the cuts, and they are now continuing to ramp up production following the lifting of United Nations (UN) sanctions.
This is significant because Iran is Saudi Arabia’s arch enemy in regional terms, illustrated by the horrific proxy wars currently taking place in both Yemen and Syria, which have been funded and supported by both countries on opposing sides.
All of this makes clear how important reducing the over-supply in the market and engineering a price rise now is to all the oil-producing nations whose government budgets have been decimated by the low oil prices. The market responded immediately to this news too, with prices surging in the immediate aftermath of the announcement. These prices continued to rise as other non-OPEC countries committed to lowering production too, although the American Petroleum Institute’s (API) announcement this week that US crude oil reserves continue to rise could begin to have a countering effect.
Oil price wars involving Saudi Arabia have not been unusual over the years, but these recent events coincided with something else, namely the declaration by Saudi Arabia at the beginning of this year that they intended to float part of state-controlled Saudi Aramco, the world’s largest oil company by capitalisation and production. In May of this year, Prince Mohammad bin Salman, Saudi Arabia’s deputy crown prince, then announced that the Saudi authorities intend to list Aramco on the Hong Kong, London and New York Stock Exchanges with an Initial Public Offering (IPO) of 5% of its equity. This was an unprecedented move, as Saudi Arabia is a notoriously secretive country, so to open the accounts of the national oil company (even partially) for scrutiny by the West took some completely by surprise.
In addition, Prince Mohammad has also indicated an intention to use the funds generated from the IPO to create a sovereign wealth fund in order to capitalise on western investment opportunities and diversify the Saudi economy so that it is not overly reliant on oil. As Prince Mohammad himself puts it; “We will not allow our country ever to be at the mercy of commodity price volatility”. Therefore, this intention to shift away from Saudi Arabia’s reliance on its oil wealth also raises the question of whether there would be a permanent shift in the status quo of the oil and gas industry as we’ve known it.
All of this adds up to greater uncertainty, thus bringing us full circle.
As such, people will now wait to see if Britain does indeed start the process of leaving The European Union, how the floatation of Aramco pans out, and arguably most importantly, whether the new President-elect’s policies can provide the stimulus to big business, and the oil industry in particular, that he promised throughout his campaign. I say this, as I feel there is a sense that, unless all of these unprecedented events of 2016 go in the right direction, creating the jobs and wealth promised, another global recession could be just around the corner.