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Gulf Cooperation Council producers wary in uncertain market

The main Gulf Opec players are wary of ceding market share to rival producers, but also wish to keep prices in the comfort zone

The Gulf’s Opec heavyweights confront difficult market conditions, with price softness upsetting their best-laid plans to market new production capacity and obtain fresh revenue injections for state exchequers that are becoming less robust. Though Gulf Arab producers are in a stronger financial position than the likes of Venezuela, Nigeria and Angola – and therefore better able to withstand a period of lower prices – they are also challenged by the recent shifts in the market. Opec’s migration from a country-focused to an aggregate quota strategy has eroded discipline, and this has seeped into the Gulf Cooperation Council (GCC) member states that have historically tended to act in concert on strategic oil matters.

Kuwait, for one, has been battling with Saudi Arabia for market share in Asia for the past year. Its break-even fiscal oil price is markedly lower than the kingdom’s, at an estimated $67 a barrel, which may make it more willing to slash official selling prices (OSPs) to win customers in Asian markets. Kuwait was selling its crude for $0.50/b less than Saudi Arabia’s OSP for its Arab Medium grade, the widest discount since at least 2004, says Reuters.

Indeed, Kuwait’s discount to Arab Medium has doubled in the past year – a response to losing market share to cheaper supply from neighbouring Iraq and Iran, whose exports rose after the easing of Western sanctions. Asia’s top four crude buyers, China, India, Japan and South Korea, imported just over 1.1 million barrels a day (b/d) of Kuwaiti crude in the first eight months of 2014, compared with 1.4m b/d in 2013. There is nothing materially new in this intra-Gulf rivalry. The only difference now is that more producers are exporting to Asia, making the job of placing barrels harder. “When there’s a decline in the oil price, the media tends to over-hype things – but if you look at Kuwait’s recent strategy, it’s nothing new. They realise it’s a competitive market out there and they need to be aggressive on price,” says one industry consultant. Kuwait and the United Arab Emirates (UAE) are both pumping about 2.8m b/d, with Qatar further behind on 740,000 b/d. None of these countries has significantly shifted its output in the past year, leaving Saudi Arabia – Opec’s central banker – to tweak production rates upwards or downwards to a magnitude of a few hundred thousand barrels.

Qatar is not as important a Gulf producer, largely because of the sharp rise in its production of natural gas, condensates, natural gas liquids, and other petroleum products that are not subject to Opec quotas. All told, output of those products exceeds the country’s crude oil production, making Opec less important to Doha and Doha less important to the group. The weaker quota discipline nonetheless puts greater onus on the Gulf players to play a more active role in the market. “Managing Opec-wide supply has become more of a job for the major Gulf oil producers – Saudi Arabia, the UAE and Kuwait,” says Daniel Kaye, senior economist at Oxford Economics, a consultancy. “The shift to cartel-wide aggregate quotas seemed to recognise that country-level quotas weren’t working,” he adds. “Too many countries were overproducing and the discipline wasn’t there. Moreover, many non-Gulf Opec governments now need high production levels to support their fiscal positions.”

The last of these factors is still an important consideration for the Gulf oil producers. Most have sizeable spending programmes to fund from their oil export receipts. Oxford Economics estimates that budget breakeven oil prices across the GCC stand at $67-131/b this year, implying that some governments will be pushed further into deficit.

GCC states depend on oil revenues, which in Kuwait’s case account for 95% of overall fiscal inflows. The Gulf states’ problem is that they are now increasingly wedded to substantial state spending. If the recent plunge in oil prices is sustained, income flows are slowed. Fortunately, most of their breakeven budget prices are still in touch with the prevailing oil price, says Kaye. “So long as oil prices stay close to $90/b they will not be panicking too much.”

In any event, fiscal breakeven levels may be less of a concern for now. While all prefer higher prices, the Gulf Opec producers know they are better equipped to withstand lower prices than others. This doesn’t mean they like low prices -- they benefited strongly from $100-plus oil – but slipping down to $80/b is no disaster.“With prices still quite high, Gulf producers will focus more on stabilising global oil market dynamics than about their own budget positions per se,” says Kaye.

There remains a strong argument in favour of collectively holding their nerve, particularly with the northern hemisphere winter on the horizon. “One calculation might be that this is a short-term cycle so they might think let’s just wait a few months and see what happens,” says Ali Ghezelbash, an independent oil consultant, referring to the recent fall in market levels. There is some anxiety in the Gulf about the potential of countries like Iraq, Iran and Venezuela to emerge as major sources of production growth. Normalisation of Iran’s relations with the West and a return to stability in Iraq could prefigure volume gains that could challenge the Gulf states.

Iraq is the main challenge, even if its production targets – calling for almost a trebling in output to 9 million b/d – are overly optimistic. “The kind of increases in oil production that the Iraqi government is forecasting over the next decade are huge, and – if delivered upon – could come online at a time when oil market balances are already quite loose. Opec could face quite a challenge in accommodating the extra Iraqi supply,” says Kaye.

Not that there is much that the Gulf producers can do about the situation. “They don’t have an interest in doing anything to sabotage Iran or Iraq’s volumes, so they will just have to accept the return of these barrels. Their concerns are rational, but the reality is there’s not much they can do about it,” says Ghezelbash. Major output increases from Iraq and Iran return is a long-term, not a near-term, problem. Few expect Iraq to be doing much more than it is at moment. The bigger issue is that Opec is producing 2m b/d more than the market needs from the group. At some point in the next six months the need for readjustment will become acute – or the Gulf states will have to take a lead in wearing a lower price.

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