By John Richardson
IT WAS tremendous whilst it lasted for the hedge funds and will have enabled them to make a lot of money – the ones who, of course, had the good sense to switch from long to short positions ahead of yesterday’s failed Doha meeting.
Chemicals companies with a decent planning department should be in a similar position to savvy hedge fund managers this morning. These type of companies will have anticipated that the meeting in Doha between some OPEC members and Russia could well have gone nowhere. They will, as a result, have told their raw material purchasing managers “Don’t overextend yourself ahead of this meeting, as there is a very good chance that oil, and so naphtha etc. will see some sharp price declines.” This kind of decent planning comes from a recognition that the oil world has changed – I believe for good.
Putting these changes into the context of the Doha meeting. Saudi Arabia was never to sign up to even a production freeze, never mind a production cut, unless Iran also agreed.
Iran was never going to agree because in this new, post sanctions world, it has to regain lost economic ground. Iran will thus go headlong for market share as volume matters more than price. And because of its geopolitical rivalry with Saudi Arabia, this is another reason to doubt why Iran would have been interested in being part of a deal. I also suspect that Iran understands that a production freeze, never mind a production cut, would ultimately have been futile anyway.
What is of critical importance to understand it that Saudi Arabia has for a long time recognised this. Saudi Arabia knows that:
- When it last led the way in cutting output back in the 1980s, we were at the beginning of another secular, long term decline in oil markets because other producers continued to pump hard. So all that happened was that the Kingdom last market share with prices still falling.
- As Mark Twain said, “history doesn’t repeat itself, but it does rhyme”. Back in the 1980s there were, of course, no US shale oil producers. But today, the US shale oil industry would have responded to a price rally resulting from an OPEC freeze or cut by upping its production. This would have then sent prices back down again.
- In statement after statement, both private and public, Saudi Arabia has made it clear that it sees a long term decline in demand growth for oil, and so it does not want to see its most valuable national asset left in the ground – in the same way that everyone already knows coal will be left in the ground.
- The Kingdom, as Deputy Crown Prince Mohammed bin Salman has made clear, is using today’s decline in oil markets to its advantage as it tries to accelerate economic diversification away from an over-reliance on crude exports. So think about it: A rebound in oil prices, based on a production freeze or cut, would have set this agenda back. And any such rebound would, for reasons I have already described, only be temporary. So Saudi Arabia would have lost more valuable time in its drive to achieve economic diversification with no major gain from greater revenues.
As I said, good chemicals company planning departments will have been ready for today’s oil-price retreat on the news that there has been no deal in Doha. They will be equally prepared for a lot more short – and long term – volatility in oil prices as the world adjusts to today’s New Normal.
Good short term planning will have taken into account more downside potential for oil from the end of the US driving season after the 4 July holiday, and what is always a weak Q3 ahead of restocking for the northern hemisphere winter.
As for long term planning, smart chemicals companies will be with Saudi Arabia in recognising that we have moved beyond peak demand growth for oil for two reasons.
Firstly, last year’s COP21 agreement underlines that for environmental reasons, there is no turning back from the shift to doing “more with less” from hydrocarbons in general.
And secondly, as we detail in our study – Demand: The New Direction for Profit – the economic Supercycle is over. Demographics in the West, and in China, could result in an extended era of weak and volatile oil prices.