Iran-Iraq Alliance and The Right Price of Oil

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According to 'Financial Times' and the WSJ, reporting several times in 2012, Iran and Iraq are "strengthening their alliance inside OPEC", raising concerns among Saudi-led moderate Arab Gulf producers that pricing discipline inside OPEC will be disrupted. The backdrop to this concern is simple:

with the EU sovereign debt crisis worsening, critical uncertainty on what exactly the US fiscal cliff means for the US economy, and growing fears for the global economy, deepening divisions within OPEC can undermine the organisation’s ability to do its claimed job of managing oil export supply and preventing violent price swings.

One thing is sure. OPEC meetings now feature strong disagreements over the acceptable price of oil, the real state of the global supply-demand balance, and recent rising tension on who should replace the current secretary general of the organisation. This is General Abdallah el-Badri of Libya, who has presided the Organization since 2007, and on 12 December was given a 1-year extension of his job, from 1 January 2013. More complicated by its details, this extension was decided by OPEC oil ministers in their conference organization, who also elected Abdulaziz Hussain, Minister of Oil of Kuwait as conference president for one year, with Dr Abdel Bari Ali Al-Arousi, Minister of Oil and Gas of Libya as Alternating President, for the same 1-year period from 1 January. The president to Dec 31, 2012 was Abdul-Kareem Luaibi Bahedh, Minister of Oil of Iraq.

The 12 December Vienna conference's final statement carefully skirted around the Iran-Iraq 'alliance' or convergence of views - which is basically that speculators profit more from high oil prices than OPEC member states - and produced a masterpiece of diplomatic jargon. It said that global oil price volatility in 2012 remained mostly due to "increased levels of speculation in commodities markets", but was exacerbated by geopolitical tensions and also by exceptional weather conditions - with the statement praising Qatar for organizing and hosting what the statement called a "successful" climate summit, COP18 in the series of UN climate meetings.

Facing Real World Facts

The OPEC conference has a delicate balancing feat to achieve, but the de facto Iran-Iraq stance on oil prices is shared by many other member states. All the states however must face reality, especially the persistent or mounting pessimism over the global economic outlook, especially the EU and Eurozone crisis, but also the US and Japanese outlook. Again for reasons more closely linked to diplomacy than facing facts, the 12 December meeting's final statement claimed that world oil consumption in 2013 "will increase slightly" but this will be "more than offset" by growth of non-OPEC supply, especially US shale oil output growth. Year average demand for or "call on" OPEC export supply was forecast at 29.7 Mbd. in 2013.

This is already a contraction - if a small one - on the probable late 2012 global demand for OPEC crude and products, the statement admitted. It is also a certain step back from OPEC's growing export surplus or net supply capability - which is especially boosted by Iraq's significantly growing export surplus. Adding in Iran's exposure to US-led oil sanctions, the de facto Iran-Iraq alliance is easy to understand.

In another classic diplomatic decision - basically to do nothing, annoying as few delegations as possible - the conference decided to maintain current export production levels which are officially counted as 30.0 Mbd: what they really are is another subject. In a sop to Iran and Iraq, the statement added that "Member Countries would, if necessary, take steps to ensure market balance", with oil prices being used as the yardstick on what constitutes "reasonable price levels" for producers and consumers. More simply this is a call for a new quota system, without saying it. Almost certainly Saudi Arabia and the other Gulf States would be assumed to most and first trim their supply on a voluntary basis.

Facing The Unreal Logic of Oil Traders

Following the 12 December OPEC meeting it took around 15 days, stretched by the holiday season, for the message to sink into the minds of traders: by 1 January 2013 prices were at $111.11 per barrel for Brent and over $91 for WTI. The unreal logic is that OPEC is by its own admission pumping more oil than the world needs - so prices must rise!

The logic is in fact double-stage: if oil prices are pushed up and stay high, OPEC will maintain output, and in a certain hard-to-specify period inventories will grow enough to make the already plain fact of oversupply even plainer. At that unspecified time interval forward from now, prices will fall.Talk about what constitutes the "reasonable price" for oil is rigorously and always talk only: at OPEC meetings no figures are ever mentioned. The trader and analyst community supplies the numbers - but these range from below $50 a barrel to around $120 a barrel.

The net result is directionless markets tagging along behind the incoming news on growth (and recession) outlooks, currency trends, CPI and purchasing manager forecasts, non-oil energy news, and of course the always intriguing subject of Arab Spring, Syrian civil war, al Qaeda in the Middle East and in Sahel Africa, and other material from the Indiana Jones collection.

We therefore have an interesting entry scene to year 2013 oil trading, with current supply/demand most surely and certainly out of balance, with too much supply. To be sure, the Mid East geopolitical scene can unwind at any time, and winter cold can storm across the northern hemisphere - both of which can bolster prices. By late January however, we could expect the accumulated set of problems for overpriced oil to start taking their toll.

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About Andrew McKillop

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