Opec learns from central banking

Khalid al-Falih, the chairman of Saudi state oil giant Aramco, addresses the 10th Global Competitiveness Forum on January 25, 2016, in the capital Riyadh. The an annual event brings together high-ranking Saudi officials and world business leaders. / AFP / Fayez Nureldine (Photo credit should read FAYEZ NURELDINE/AFP/Getty Images)©AFP

Central bankers have long understood that a few well-placed words can wield nearly as much power as pulling the actual levers of monetary policy. It is a lesson that Opec and Saudi Arabia has started to heed.

Just a few short sentences from Saudi Arabia’s energy minister Khalid al-Falih last week sent hedge funds scrambling to cover large bets against the oil price, subsequently propelling Brent crude 10 per cent higher and largely silencing fears the market was on the cusp of another rout.


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Following calls from Venezuela for big producers to revisit the idea of freezing output, Mr Falih said the kingdom was willing to “discuss any possible action” needed “to stabilise” prices when Opec ministers gather informally at a conference next month.

For those that had written off Opec and Saudi Arabia’s position as “the central bank of oil” the market’s reaction was notable. Most long-term Opec watchers expect no official agreement to emerge from the Algeria gathering, even as oil-dependent economies struggle under the weight of a two-year price collapse.

Still, prices shot higher at the mere threat of action.

“A lot of traders appear to hold the view that eventually there’s going to be so much pain among Opec that they’ll have to do something,” says Jamie Webster of Columbia University’s Center on Global Energy Policy. “I don’t see anything to make me think outcome is going to be different this time.”

Instead, analysts see an attempt by Opec and Saudi Arabia to verbally intervene in the market during the long process of bringing supply and demand back towards balance, as they stick with the policy of keeping output high to squeeze out higher cost rivals.

That Saudi-led effort, in place since late 2014, is starting to show signs of working. Opec production has risen to its highest on record and supplies outside the group are expected to fall this year.

However, the process is taking time, leaving the oil price vulnerable to attacks from short-sellers when seasonal surpluses emerge, as they did recently in refined fuels markets like gasoline. Where once Opec might have cut output, verbally intervening is now the preferred option.

“By raising the possibility of a freeze it can help them get through this period while the rebalancing continues,” says Ann-Louise Hittle, chief analyst at Wood Mackenzie. “It’s almost as if there’s an attempt to talk the market through what was always going to be a long process.”

The reason last week’s Saudi comments pushed Brent up so much largely reflects market positioning, say traders.

Alarmed by the emerging gasoline glut, hedge funds bet aggressively on lower prices in July, leaving the market primed for buying back and closing out bearish bets. Mr Falih blamed “large short positions” for prices undershooting.

Chart: Oil market

The biggest barrier to Saudi Arabia taking more decisive action is its relationship with fellow Opec member Iran. Saudi Arabia has always said that it is willing to consider anything to help balance the market, including production cuts, but only if other big suppliers join in.

Russia, the biggest oil exporter outside Opec, agreed to such a deal in April in Doha but Saudi Arabia scuppered the deal at the last minute, when Deputy Crown Prince Mohammed bin Salman — the favoured son of the king — ruled there could be no agreement without Iran.

A senior Gulf Opec source says the kingdom believed Russia’s recent remarks about potential involvement were positive for any collaborative efforts that were being led by Qatar, Venezuela and Algeria. However he acknowledges Iran’s position was still uncertain.

After years of sanctions Iran is attempting to win back lost market share and has repeatedly signalled it has no plans to limit output. Iran’s oil minister Bijan Zangeneh said on Thursday he had not decided if he would attend September’s gathering, according to media reports.

“Iran will remain a stumbling block as it simply cannot accept a ceiling on its production,” says Amrita Sen, chief analyst at London-based consultancy Energy Aspects.

Like Iran, Saudi Arabia has also been increasing production, reaching a record 10.7m b/d day in July, up from 10.2m b/d in January when the idea of a freeze was first mooted.

The country’s crude output normally rises in the summer months to meet peak electricity consumption but in his comments to the Saudi Press Agency last week Mr Falih also pointed to “strong demand for its crude” as a reason for its record production.

For some, that remark was significant because it indicates a greater willingness to keep the taps wide open as its competition with Iran heats up.

“If the talks fail, which is likely, the market should not entirely rule out the possibility that Saudi Arabia will give up and throw in the towel, and keep output high, at or above July’s level,” says Mrs Sen.

Investors may need to wait to see if the Kingdom does scale back its summer output as it has done it previous year. But if it keeps producing 10.7m b/d or more than the oil market may not come into balance next year as most analysts currently expect.

It would be a test, analysts say, of the power of verbal intervention to keep the bears at bay. At some point words may need to be backed by action.

Emmanuel Ibe Kachikwu, Nigeria’s oil minister told CNN this week that he was “not optimistic” about any production cuts in September. “we’ve tried that a couple of times and I think we’ve not been able to get the unity we need.”

He says it was important nonetheless to maintain dialogue with non-Opec producers

Ms Hittle at Wood Mackenzie adds in many ways Opec and Saudi Arabia’s trajectory was not that different from most central banks in the post-financial crisis world, who have often delayed adjusting interest rates.

“It used to be that they were compared to a central bank as they would take action. Now, like many central banks, guidance has become much more common,” she says.

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