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Oil Traders Say OPEC May Be Heading for Price War

Maritime Activity Reports, Inc.

October 2, 2014

Saudi Arabia's decision to slash the official selling price for its oil has sparked trader talk of an emerging OPEC price cutting war, as members of the producer group could compete to defend their market share amid ample supplies and tepid demand.

Industry and trading sources in the Middle East say there was now a risk of a race to the bottom, at a time when many were calling for unity from members of the Organization of the Petroleum Exporting Countries (OPEC) as it faces one of the steepest price slides since the financial crisis.

The group's next meeting in November will be closely-watched to see whether it cuts supply. Benchmark Brent crude prices continued to slide towards $90 a barrel on Thursday, a level that leaves many OPEC members - and other large producers like Russia - with painful budget gaps.

Some OPEC countries are becoming more worried about the price drop and calling for supply cuts, but its core Gulf members are still betting winter demand will revive the market.

"The Saudis will not cut unless it is a collective cut, they have to hear that others are saying that as well," one industry observer said, speaking on condition of anonymity.

"It is like the start of a bad competition to see who's willing to stay until the end."

International oil prices have fallen by 20 percent from a year high above $115 a barrel in June as faster-than-expected growth in U.S. shale oil output and the return of production in Libya has contributed to a glut of crude in the market.

Demand is also growing at little over half the rate many anticipated at the start of the year leading some to question whether there has been a structural shift in the market. More than three years of prices averaging near $110 a barrel have curbed consumption as well as stimulating higher output.

Iraq and other OPEC members have also been cutting their Official Selling Prices (OSPs) as Brent has fallen, though the size of the Saudi price cut still surprised many observers.

Saudi lowered the price difference of its flagship Arab light crude to benchmark crudes by more than $1 a barrel, a substantial move in a cents-per-barrel business.

"These cuts are unexpectedly large," said one senior figure at a major oil trading firm. "I think an element of forcing cuts by other OPEC members by competition may play a role."

Carsten Fritsch, commodities analyst at Commerzbank said, the price cuts had taken Saudi price differentials to the lowest level since December 2008, when crude prices were collapsing during the financial crisis.

"Such measures give rise to doubts about OPEC's longstanding strategy of striving above all for price stability," Fritsch said.

"OPEC appears to be gearing up for a price war. We therefore do not expect prices to stabilise until this impression disappears and OPEC returns to coordinated production cuts."

The German bank, which had the second-highest forecast for Brent prices next year in a Reuters monthly poll published this week, on Thursday lowered its 2015 Brent forecast to $105 a barrel from $110 a barrel saying OPEC would eventually be forced to cut output.

Change of Policy?
Some trading sources said the Saudi price cut may just be a response to market conditions rather than an official change in output policy, though the world's largest exporter has so far kept supply to global markets steady-to-slightly-higher through September.

"There is a seasonal softening in demand and I think that the marketing strategy of Aramco is to accommodate the shift down with lower prices to protect the kingdom's own market share," said Sadad al-Husseini, a former top executive at Aramco.

Saudi Arabia and its Gulf state allies in the United Arab Emirates and Kuwait are better placed to weather a period of lower prices than any other OPEC member or major oil producer, having run a substantial budget surplus for years.

Some analysts say the kingdom can afford to see rivals like Iran and Russia suffer a period of low prices, while also potentially curbing some investment in higher-priced oil projects that have contributed to the glut in supplies from North America.

These so-called 'marginal cost' projects such as Canadian tar sands and the shale oil plays in the Bakken in North Dakota and Eagle Ford in Texas generally require a price of at least $70-$80 a barrel to keep operating.

But even prices slipping towards $90 a barrel may curb the appetite for further investment. Already Norway's state-owned Statoil has postponed a 40,000 barrel-per-day oil sands project in Alberta, citing concerns about inflation as well as tight pipeline space from the region.

(By David Sheppard and Rania El Gamal; Additional reporting by Reem Shamseddine in Khobar and Alex Lawler in London, editing by William Hardy)

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