Trump is fracturing OPEC

5 July 2018

Trump’s tweet over the weekend that Saudi Arabia agreed to add two million barrels per day (mb/d) of supply confused the oil markets, pushing prices down a bit on Monday.

Most analysts dismissed the statement, concluding that Trump was confused when the Saudis told him they have two mb/d of spare capacity, and not that they had planned to bring that capacity online.

A few days on from that episode, however, it actually doesn’t look that black and white, reports

Indeed, Trump’s tweet suggests that he very much believes that two mb/d of Saudi supply is coming online, and despite the attempt by the Saudis to clarify, by stating that they have surplus capacity waiting to be used in the event of a pinch, the statement was interpreted in different ways by the oil market.

After all, the point of Saudi Arabia’s spare capacity has always been to ensure market stability, so it doesn’t seem as if there is any major change in policy. On the other hand, many oil market watchers viewed the statement as Saudi Arabia’s tacit agreement with the Trump administration to ramp up supply when Iranian oil goes offline.

Recent data suggests that Saudi Arabia already began ramping up production way more than it said it would under the OPEC+ agreement even before the meeting. The agreement called for a return to 100% compliance, which would translate into an increase of 600,000 bpd to 1 mb/d. Saudi officials suggested the upper end of that range was almost a formality, and the lower figure would end up being what was likely.

But even as Saudi Arabia worked hard to maintain the cohesion of the OPEC+ group, it quietly ramped up output in June. Estimates vary, but here are a few numbers that we have to go by. Bloomberg estimates Saudi output jumped by 330,000 bpd in June to 10.3 mb/d. Reuters says production surged by much more, rising by 700,000 bpd to 10.7 mb/d. If the latter is true, production would stand at close to the all-time high of around 10.7 mb/d.

Looking forward, Bloomberg and Reuters both report that Saudi Arabia won’t stop there, and instead will ramp up to 10.8 or 11 mb/d in July.

The numbers are significant because they would suggest that even as Saudi Arabia cobbled together a reasonable deal in Vienna, it had plans to blow through the ceiling that it was committing to. In other words, OPEC+ agreed to add 1 mb/d, but Saudi Arabia alone is poised to increase by that amount.

Many OPEC members are already crying foul, accusing Saudi Arabia of doing Trump’s bidding. It isn’t clear that Saudi Arabia will go as far as increasing by 2 mb/d, as Trump wants, but the promise to plug any supply gap is a not-so-subtle acknowledgement that Riyadh is ready backstop Washington’s plan to shut in Iranian supply.

“We think that Trump’s interventions are more likely to unsettle than reassure the oil market,” Standard Chartered wrote in a note. “The comments carry the implicit suggestions that supply deficits will require all of the world’s remaining spare production capacity to come online; that US oil policy is based primarily on the use of Saudi spare capacity to fill any gaps created by other US actions; and that the US assumes there is as much as 2mb/d available promptly.”

Iran is firing back, arguing that if Saudi Arabia produces above its 10.06 mb/d quota it would breach the OPEC+ agreement. Iran also issued a veiled threat to disrupt Saudi shipments in the Strait of Hormuz.=

With the oil sectors of so many OPEC members wounded, they are largely powerless to stop Saudi Arabia from pursuing its own course. Plus, with Russian cooperation, Saudi Arabia no longer sees the utility in restraining its ambitions to adhere to the wishes of other OPEC members.

Thus, the aggressive anti-Iran campaign from Washington – a campaign that Riyadh supports – is driving a wedge between OPEC members. "Putting aside the fact that Saudi Arabia has no such capacity to bolster its crude output, this demand could be inferred as an order for the kingdom to walk out of OPEC," Iran’s OPEC governor Hossein Kazempour said, referring to Trump’s request for two mb/d of Saudi supply, according to S&P Global Platts.

Leaving aside the wisdom of burning through the entirety of global spare capacity, or whether Saudi Arabia will actually go that far, the seeming willingness to comply with Trump’s request for more oil, which will come at the direct expense of an OPEC member, could fracture the cartel. OPEC could continue to exist on paper, and it will continue to meet, but Saudi Arabia and Russia (and to a lesser extent, a few Gulf States) are the only ones coordinating oil market policy. This dynamic has been underway for the better part of two years now, but President Trump is accelerating these changes.

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