A well-oiled machine: The new dynamics of Middle Eastern oil

By: Daphne Tong, Vaishakh Pillay

Research Head: Tan Chok Geow

Editor: Sakshi Sanganeria

Abstract

Crude oil is one of the most important energy sources and its production has been dominated by a few players, notably the OPEC countries in the Middle East. The authors investigate whether reliance on OPEC oil has changed by looking at data from 2019. Data shows that although the United States, Canada and Russia have increased their oil production, the Asian region is still heavily dependent on the Middle East for oil. The authors then analyse how exogenous factors, such as politics and epidemics, can affect the global demand and overall price of oil. Findings show that exogenous factors can have a significant impact and force OPEC to adjust production output (in order to influence oil prices). Coupled with falling reliance on OPEC for oil (given the rising use of alternative sources of energy), these factors could signal a daunting future for oil producers in the Middle East.

The ever-increasing demand for oil has kept oil prices at an all-time high-forcing a rise in oil extraction (World Population Review, 2020).

Currently, the top producers of oil is the United States. However, amongst the top ten producers, there are five Middle Eastern countries; Saudi Arabia, Iraq, UAE, Kuwait and Iran. According to OPEC, 79.4% of the world’s proven oil reserves are located in OPEC member countries, with the bulk of OPEC oil reserves in the Middle East (OPEC, 2019).

Asia is the largest importer of oil from the Middle East, with an estimated 76% of the 17.3 million barrels per day (BPD) of crude and condensate flowing through the Straits of Hormuz in 2018 going to Asia (Maxwell, 2020).

However, due to the US revolutionisingshale oil extraction, climate activism in the West as well as widening use of alternative sources of fuel, demand and production of crude oil from OPEC is expected to fall to 32.8 million (BPD) by 2024 (Lawler, 2019).

The reduced reliance on Middle Eastern oil by the US has been a hot topic for debate.

Recently, it was brought to the forefront of world news by US President Donald Trump’s assertions that the US is energy-independent and does not need Middle East oil. On the surface, Trump’s assertions seem to be well-founded. In 2019, less than 5% of the 16.5 million BPD of crude and condensate from the region went to American refineries (Lee, 2020). Yet this does not paint an accurate picture of dependence on Middle Eastern oil. Individually, the US is the fifth-biggest buyer of Middle Eastern crude, with one in every eight barrels of crude imported into the US coming from that region. According to the EIA, OPEC represented 17% of total US oil imports in May 2019. In the event of a disruption in oil production, the US will turn to Saudi Arabia to meet her oil demands, unless the Strategic Petroleum Reserve is used (Saadi & Wang, 2020).

Relationships between the US and the Middle Eastern region thus have to be managed cautiously. However, recent events have put a strain on these relations. The US drone strike on a top Iranian military general has caused mass outrage in Iran. This is of major concern to the US as it limits the number of sources from which to import heavy crude oil (Lee, 2020). The conflict also has other potentially far-reaching consequences, as any disruption to the flow of oil through the Straits of Hormuz could have a severe impact on the global oil price (Knipp, 2020).

Exogenous shocks, which are events unexplainable by economics, can also affect oil supplies and impact oil prices. The recent coronavirus outbreak where China was hardest hit with up to 60,000 confirmed cases (Worldometers,2020) caused cities to be locked down, travel bans imposed, and factories remained closed to contain the virus. According to CNA, travel restrictions have affected the movement of over50million people in China (CNA,2020). Cirium, an air-travel analysis firm, suggests that 26% of scheduled services to and from China between Jan. 23 and Feb. 3 had been suspended by airlines (Bloomberg, 2020). With production halted in many factories and closure of ports in China, demand for oil in the transportation of supplies of components and finished goods has declined. According to WSJ, the transport and industrial sectors together constitute 70% of China’s petroleum demand ( WSJ,2020). Being the largest importer of oil, it is inevitable that the coronavirus has a profound impact on oil prices.With falling oil demand, oil prices had fallen by more than 20% to below$55 a barrel as demand is expected to fall by 40%, with JPMorgan Chase & Co. slashing its global oil forecasts for the first quarter from 1.15 million BPD to 500,000 BPD (WSJ,2020). Similarly, the OPEC responded by recommending a quick supply cut by 600,000 bpd to stem the price fall. Evidently, oil is a commodity that is particularly volatile at times given the potential for endogenous or exogenous events.Following tensions with Iran, oil prices rose 4% to $68.60 per barrel (CNN, 2020) but the current coronavirus situation that is mainly deterministic of oil prices has caused a plunge. While oil prices are expected to recover after supply cuts by OPEC to reduce excess supplies and stem the price slump, OPEC's effectiveness in influencing oil prices is also dependent on the extent to which its members comply with production quotas.Depending on the severity of the situations outlined above, the demand for oil is still uncertain. Should the situation improve quickly and businesses resume operations, demand for oil would steadily increase. Otherwise, a longer recovery period would mean that demand remains sluggish and there would be a need for a larger production cut of 1 million BPD (WSJ,2020) by OPEC.

References

1. Davies, W., & Ha, K. O. (2020). Unprecedented China Travel Bans Leave ThousandsStranded. Retrieved from:https://www.bloomberg.com/news/articles/2020-02-06/china-travel-bans-leave-thousands-stranded-around-the-world

2.Faucon, B., & Said, S. (2020). OPEC, Allies Weigh Deeper Oil Production Cuts toCounter Coronavirus's Impact. Retrieved from: https://www.wsj.com/articles/opec-allies-weigh-deeper-oil-production-cuts-to-counter-coronaviruss-impact-11580826459?mod=article_inline

3.He, L. (2020). Oil prices surge 4% after Iran military leader killed in US strike. Retrievedfrom: https://edition.cnn.com/2020/01/02/investing/oil-prices-iran-commander-baghdad/index.html

4.Knipp, K. (2020). Iran-US tensions put India in a bind. Retrieved from DW: https://www.dw.com/en/iran-us-tensions-put-india-in-a-bind/a-52357124

5.Lawler,A. (2019). OPEC sees its oil market share shrinking, lowers demand view. Retrieved from REUTERS: https://www.reuters.com/article/us-oil-opec-outlook/opec-sees-its-oil-market-share-shrinking-lowers-demand-view-idUSKBN1XF105

6.Lee, J. (2020). Trump Is Wrong. The U.S. Does Need Middle East Oil. Retrieved from Bloomberg: https://www.bloomberg.com/opinion/articles/2020-01-12/trump-is-wrong-the-u-s-does-need-middle-east-oil

7.Maxwell, K. (2020). ACTBOX-Asia is region most dependent on Middle East crude oil,LNG supplies. Retrieved from CNBC:https://www.cnbc.com/2020/01/08/reuters-america-factbox-asia-is-region-most-dependent-on-middle-east-crude-oil-lng-supplies.html

8.OPEC. (2019). OPEC share of world crude oil reserves,2018. Retrieved from Organisation of the Petroleum Exporting Countries: https://www.opec.org/opec_web/en/data_graphs/330.htm

9.Saadi, D., & Wang, H. (2020). US still needs Middle East oil, OPEC spare capacity:analysts . Retrieved from S&P Global:https://www.spglobal.com/platts/en/market-insights/latest-news/oil/011220-us-still-needs-middle-east-oil-opec-spare-capacity-analysts

10.Taplin, N. (2020). As Coronavirus Spreads, China Chokes on Oil.Retrieved from: https://www.wsj.com/articles/as-coronavirus-spreads-china-chokes-on-oil-11580904207

11.Toy, S. (2020). Oil Falls for Fifth Week as Investors Weigh Coronavirus Fallout.Retrieved from: https://www.wsj.com/articles/oil-prices-swing-as-investors-weigh-coronavirus-fallout-11581094414

12.Pfeiffer, D. (2020). Commentary: China's coronavirus lockdown on cities was necessary.But there are more important lessons. Retrieved from:https://www.channelnewsasia.com/news/commentary/china-wuhan-coronavirus-lockdown-cities-working-quarantine-effe-12400400

13.World Population Review. (2020). Oil Producing Countries 2020. Retrieved from world population review: http://worldpopulationreview.com/countries/oil-producing-countries/