Oil Price Forecast Is Bullish for Crude in 2016
The majority of oil price forecasts remain pessimistic in the sense that they expect oil prices to remain at current levels, drop below $30.00 a barrel in 2016, or shoot back toward the $100.00 mark. The key is what Saudi Arabia decides to do at the next Organization of the Petroleum Exporting Countries (OPEC) summit, which will take place in Vienna on December 4.
If the summit focuses on one thing, it will surely be the search for a solution for, or at least a strategy to resolve, the oil price crisis. Venezuela wants the 2016 oil price target to be $88.00 a barrel, which it considers the bare minimum needed to cover its investment. Indonesia, meanwhile, has decided to rejoin OPEC after a 12-year hiatus, bringing the official number of OPEC members to 13.
This Could Send Oil Prices Soaring in 2016
If Indonesia has rejoined, it is because it hopes to influence the trend in the international industry’s most famous oil price–regulating institution. This year, Saudi Arabia is pumping record amounts of oil. The Saudi logic is that oil prices must remain low for now in order to protect market share, so long as Brent continues to trade near the lowest level in six years.
Whereas Venezuela has not inhibited its fears of oil prices falling too low, the Saudis, who appear steadfast in pursuing their stoic efforts to keep flooding the market, pushing oil prices down, do have an Achilles heel to confront. The slide of oil revenues has forced the kingdom to tap into savings, while selling debt to preserve the exchange rate peg of its riyal against the dollar, a policy adopted in 1986. This will bring the Saudi leadership to a crossroads. Either it cuts production to help boost prices or it adjusts the exchange riyal to curb the outflow of its foreign exchange reserves.
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On November 19, Bank of America Corporation analysts, led by one Francisco Blanch, pointed to the depreciation of the Saudi riyal as the catalyst for upping its oil price forecast in 2016. (Source: “Cut Oil Supply or Drop Riyal Peg? Saudis Face ‘Critical’ Choice,” Bloomberg, November 22, 2015.) The risk of the Saudis devaluating the currency may be unlikely, but it would be highly impactful. Accordingly, given the choice, it is much more politically expedient to cut oil production than allow the riyal to devalue and be subject to the whims of an increasingly influential geopolitical risk, given that Saudi Arabia is a key player, regardless of what happens in the Syrian war and the war on ISIS.
The U.S. dollar, as noted more than once by this publication, is heading for parity with the euro. The dollar may even surpass the euro, even if economic growth in the eurozone gains strength, because of the European Central Bank’s policy of extending quantitative easing in order to achieve a two-percent inflation rate.
A weak riyal, no longer protected by the dollar peg, would make imports to Saudi Arabia much more expensive and the kingdom is a large importer of goods from all over, given that there is little domestic production of consumer goods. Contrary to stereotypes, the average Saudi citizen is not especially rich and the social phenomenon of rising poverty is the open “secret” of Saudi society.
Saudi Arabia was able to stave off the wave of protests, rather haplessly named the “Arab Spring” (more of an Arab winter in its execution), by a boost in social services spending and public sector salary increases. A free-floating riyal in the context of higher sociopolitical risk and import dependency is an explosive cocktail, even if Saudi Arabia’s reserves do remain significant.
The riyal-dollar peg allowed Saudi Arabia to survive the 1990s, when oil prices were at historical lows, according to Shaun Osborne, chief foreign currency strategist for Scotiabank. Bank of America, for its part, has pointed out that the Chinese yuan could come under pressure now that reserves at central banks around the world have dropped in a context of an ever-stronger likelihood of rising interest rates in the United States.
The bank believes that a collapse of the yuan may finally force the hand of Saudi Arabia in cutting production to raise the oil price. Saudi Arabia, the largest OPEC member, has produced more than 10 million barrels of oil per day in each of the past eight months and in July, it pumped a record 10.6 million barrels per day.
Oil Price Forecast 2016: The Russia Factor
Meanwhile, Russia, which is not an OPEC member, will put pressure on OPEC at the forthcoming summit. Putin’s policies are certainly pushing in that direction, with a view to reverse the downtrend in oil prices.
Moscow has a special relationship with Venezuela and Iran, both of which are pushing for OPEC production cuts. Now, Russia is laying the groundwork for a partnership with Iraq as well, which is moving ever closer to Iran, given its Shiite-dominated leadership.
Russia’s OPEC “partners” would also get support from other OPEC members that are also finding it hard to sustain production on low oil prices, including Angola, Nigeria, Libya, Algeria, Ecuador, and Venezuela. This sizeable group, along with the aforementioned Iran and Iraq, account for more than half of OPEC. The latter prefer production cuts to support oil prices, contrasting with the Saudi camp, which includes Saudi Arabia and the usual Gulf suspects, Kuwait, the United Arab Emirates, and Qatar.
Whatever the outcome of the OPEC meeting on December 4 in Vienna, the member states will have to decide whether to continue producing at the current rates without knowing what will happen in Syria and the Middle East as a whole over the next few months at a time of heightened risk.
Saudi Arabia cannot rely on the U.S. for support. Indeed, the U.S. wants to isolate Russia and many would suggest that cheap oil has been encouraged as a geopolitical tool, but U.S. shale oil producers would certainly support the Russian camp, urging production cuts in order to sustain their business models.
Russia’s energy minister, Arkady Dvorkovich, was adamant that Saudi Arabia’s policy has forced most of the OPEC producers to suffer the side effects of the kingdom’s attempt to eliminate competition, flooding the world with overproduction. (Source: “Russia flirts with Saudi Arabia as OPEC pain deepens,” The Telegraph, September 6, 2015.)
Given Russia’s anger over Turkey’s ambiguity in challenging the rise of the Islamic State (Turkey being one of the countries that, in concert with the Saudis, have done the most to destabilize the Syrian regime, a Russian ally), Russia could retaliate by diligently driving a wedge in OPEC to break it into two camps. One of these, the larger one, would be compliant with the Russian position and effectively work to isolate Saudi Arabia and the Gulf States.
In the geopolitical theatre, Russia has announced that it will deploy the cruiser “Movska” off the coast of Syria, in the wake of the downing of one of its “Sukhoi Su-24Ms” by Turkey with the goal of destroying anything that threatens Russian planes. There is a serious risk of escalation of tensions in the region, which will keep oil markets on edge for some time.
At that point, even the Saudis will compromise, even if it will not be easy for Russia to force its hand. Saudi Arabia has done everything possible to force oil prices down, even offering crude oil to Asian buyers at discounted rates just to preserve its market share, while maintaining high production volumes. The Saudis, in turn, would much rather see Russia and other non-OPEC members cut their oil production before it changes its current policy.
The Saudi pressure on Russia may backfire, because of the return of Iran to the global oil market in 2016, after the lifting of sanctions following the agreement on its nuclear capability. Surely, Iran will need massive investments to accelerate production levels, such as to add a million barrels per day to the current 2.8 million barrels per day.
At that point, the Saudis might be concerned enough to start cutting production. Russia, one of Iran’s most important allies, through bilateral agreements with its energy companies or similar tools might well decide to finance Iran’s oil production boost if only to put pressure on Riyadh. In addition, given the good relations between the Kremlin and the Chinese Communist Party, a strategic alliance with Moscow could be very beneficial to Iran and Iraq to snatch market shares from Saudi Arabia.
The Bottom Line on Oil Prices
Unlike Saudi Arabia, which has a fixed peg to the dollar, Russia, Iran, and Iraq may be allowed to float their currencies and, if necessary, use foreign exchange as a monetary lever. Ultimately, it would be more politically advantageous for Saudi Arabia to cut production, which would drive up the price of Brent oil prices.
It’s either that or it de-pegs the riyal from the dollar, but the Saudi central bank would prefer devaluing nothing. Vladimir Putin may have gained the upper hand, forcing OPEC and his opponents to react. All of this means a bullish oil price forecast for 2016.