Oil Prices: This Deal Could Send Oil Prices Soaring

Oil PricesAs we suggested a few weeks ago, an international agreement over Syria would help boost oil prices. This is an early effect of the agreement that U.S. Secretary of State John Kerry, his Russian counterpart Sergei Lavrov, and representatives from 17 countries signed in Munich. Oil prices opened above $27.00 per barrel in Asian markets and touched their lowest since May 2003—$26.21. Brent futures rose $1.33 to $31.39.

It’s no fluke that the marathon talks of the so-called International Support Group for Syria, which ended on February 11, coincided with an opening from a key OPEC state. United Arab Emirates (UAE) Energy Minister Suhail Al Mazrouei said OPEC now hopes to collaborate with other producers to stabilize oil markets. (Source: “Crude rallies into the weekend amid hope for production cuts,” BNN, February 12, 2016.)

The agreement to stop hostilities has tempered Saudi Arabia and its plan to invade Syria. Russia warned that direct Saudi military action in Syria would promptly destabilize the oil market. (Source: “Russia: Saudi Ground Troops In Syria Could ‘Immediately’ Destabilize Oil Market,” Oil Pro, February 9, 2016.)

The Syria agreement now makes the Saudi intervention unlikely. In fact, it has opened the path for more constructive talks between Russia and Saudi-controlled OPEC. There are much higher chances now that such talks could deliver an agreement to cut output.

British newspaper The Guardian reported that the Saudis wanted to take a more aggressive stance in Syria. The kingdom says it is ready to deploy thousands of soldiers to fight against the Islamic State, perhaps in coordination with Turkey. (Source: “Saudi Arabia offers to send ground troops to Syria to fight ISIS,” The Guardian, February 4, 2016.)

Russia and the United States have exchanged troubling signals.

Neither President Obama nor President Putin intends to get anywhere close to a direct confrontation. In fact, the talks suggest that they want to engage in easing the current indirect conflict. The Russian economy is fragile. The American one is at risk. Obama does not want to engage his people in a new war after getting a Nobel Prize…for a non-existent peace in the Middle East.

Russia and the U.S. appear to be shifting into a more diplomatic mode. They may have actually agreed to end the conflict in Syria. Moscow would keep its important role in the Middle East and a strategic base in the Mediterranean. President Obama can score one for the good people in Washington.

He can claim to have won the war by opening the way for a new, if not exactly a democratic one, in the Middle East. In fact, Obama would be taking a major step back, one that even Rand Paul might like. The U.S.-Russia agreement has opened the way for OPEC and Russia to hold fruitful talks on oil prices.

The agreement still leaves enough tension between Sunnis and Shiites to fuel the perception of oil supply risk. Iran, Saudi Arabia’s Shiite archrival, would certainly oblige in taking part in this oil version of the Cold War.

As for Syria, the ceasefire talks worked, because the arrangements do not really spell the end of hostilities. Russia will continue to bombard Islamic State positions—and other rebels—in order to complete its offensive on Aleppo. This will allow Damascus to resume control over much of eastern Syria.

The Munich talks also worked because they were more modest. The goal was to revive the actual, but deadlocked, peace talks that ended last week. The participants reaffirmed their commitment along vague lines. They agree to encourage a political transition when the conditions on the ground improve.

This is still good news for oil futures.

As we predicted a few weeks ago, if the major powers fighting proxy wars in Syria manage to agree on just one point, Russia and Saudi Arabia can start talking about cutting their oil output. Russia and Saudi Arabia, even more than Iran or the United States, hold the key to understanding where oil prices will go in this context.

Dmitry Peskov, representative for President Putin, did not say if Russia intends to observe the next OPEC summit. Still, the chances of Russia joining are much higher now. Venezuela, a broke member of OPEC, has been calling for an emergency meeting of producers to discuss steps to prop up prices. (Source: “Saudi, Venezuela talk of OPEC, non-OPEC cooperation to stabilize oil market: SPA,” Reuters, February 7, 2016.)

Oil production in Russia in 2015 reached a record for the post-Soviet period. It hit as much as 10.7 million barrels a day on average. (Source: “Russian Oil and Condensate Production Hits Post-Soviet Record,” Rigzone, July 14, 2015.) Therefore, the Russians are eager to talk to the Saudis.

Russia and the United States and Saudi Arabia are still far apart over Syria—but less so on oil. The Munich agreement has revamped cooperation. The Syria Peace talks could well be the catalyst to reverse oil’s bearish slide toward $20.00 or even $10.00 oil, as some analysts predict.

The risks related to the unprecedented flow of refugees from Syria and beyond has raised many security issues. The higher security risks have, in turn, raised fears of recession and put pressure on the euro. The European Central Bank (ECB) continues to ease monetary policy to stimulate economic growth.

However, this betrays fears of economic weakness and implies lower demand for oil.

Low economic growth in the EU also means less demand for goods from China. It’s still export-dominated economy has started to show signs of weakness itself—also not good for oil prices. In 2015, more than one million people have been knocking at Europe’s door. In response, EU countries have started to question fundamental pillars of the Union, such as the Schengen agreement. This has guaranteed open borders between member states for more than 20 years.

The Bottom Line for Oil Prices

A bullish oil price scenario is also likely because Saudi Arabia’s increased production cannot last much longer. Iran’s importance in the Middle East and the support for its allies have forced Saudi Arabia to accept the Russian-Iranian axis. This means there will be greater pressure to reduce production.

The Saudis will also breathe a sigh of relief. They have flooded the oil market to keep prices low, constraining the kingdom’s budget. This has compromised the generous welfare measures that help ensure stability in the country at risk. OPEC members will follow suit, resulting in a bullish Brent oil price forecast in 2016.

President Putin is not interested in weaving an intricate diplomatic and military strategy for just a tiny increase. Putin expects oil to return to prices that accommodate Russian budgetary constraints. This means upwards of $80.00 per barrel. (Source: “Russian engagement in Syria is Putin’s ultimate power play,The Hill, October 27, 2015.)

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