Raw Input. Questions well up for crude oil

Going by his actions of the past fortnight, it’s all but apparent that Donald Trump’s regime in the US will have a big impact not only on international geopolitics but also on global energy markets, including oil.

Trump’s ‘America First’ world view, his pro-US business and energy agenda, ‘extreme vetting’ actions against immigrants from certain Muslim nations, including major oil producers Iran and Iraq, and bellicose statements against Iran could cause upheavals and uncertainties in the oil markets. How oil prices move will depend on the net impact of these factors.

Among Trump’s first actions as US President were approvals for two major cross-country oil pipelines — Keystone XL and Dakota Access, blocked by the previous Obama administration over environmental concerns, are in line with Trump’s election promises of giving a boost to energy projects in the US.

Under Trump, the US shale industry is also set for many perks. The new administration will likely make things easier for US shale oil and gas producers through financial incentives, tax breaks and easier land and environmental clearances.

This could lower their cost of production and help them compete even at lower prices against the traditional global oil and gas producers. Apart from keeping the US and global oil markets well-supplied, this should keep a cap on oil prices, despite the recent deals between OPEC and some non-OPEC countries to cut output.

The sharp rise in shale oil output in the US over the past few years, aided by technologies such as hydraulic fracking, was a key reason for the oversupply in the crude oil market since 2014. Rapid growth in output in the US, among the largest consumers of oil, saw its imports plummet.

The Organisation of the Petroleum Exporting Countries (OPEC), dominated by Saudi Arabia, responded to the US shale challenge by maintaining and even increasing production levels. This exacerbated crude oil’s fall.

The Saudi strategy was to maintain market share through low prices while making it unviable for US shale oil producers to continue in business. The strategy worked to some extent, with some US producers being laid low.

But, others survived, aided by technological improvements that lowered their cost of production. Ergo, the US shale industry held up despite the strain, a sign that the Saudi strategy was not yielding the desired results. Low prices not only hurt US shale producers but also put a heavy financial stress on OPEC members, including Saudi Arabia.

Meanwhile, the election of Trump as US President in November further queered the pitch for OPEC; a big supporter of US energy was headed for the Oval Office. With pressure building up within OPEC for higher oil prices, the Saudis, after holding out more than two years, decided to change tack.

So, in late November, the OPEC agreed to cut production by 1.2 million barrels a day. Soon, 11 non-OPEC countries including mega producer Russia joined hands with OPEC and agreed to cut output by about 0.6 million barrels a day. With these deals, the first ones in several years, nearly 2 per cent of the global oil output would be taken out of the market.

These agreements, to be implemented initially for six months from January 2017, saw oil rally sharply — 20 per cent in a fortnight from about $46 to $55 a barrel in the hope that the global oversupply will finally ease.

Tellingly, despite the oil cuts coming into force in 2017, prices have not gone beyond $55-56 a barrel. Going forward, what will really matter is continued compliance with the deals.

There have been instances in the past of oil producers not keeping their word and deals falling through. The recent deals could be tough to implement, especially given the antipathy between major OPEC producers Saudi Arabia and Iran.

Even if the deals are sustained, there will likely be a cap around $60 a barrel. At this level, many US shale producers, lying low for the time being, could make a comeback. Incentives by the Trump administration could act as a sweetener. Over the past few years, shale has helped the US bolster its energy security, adding to its geopolitical heft. Trump is unlikely to let go of this advantage.

On the other hand, the risk of heightened geopolitical tensions impacting global oil supplies is real. The plan to impose 20 per cent import tax on Mexican goods to finance the proposed US-Mexico border wall could see oil supply from Mexico to the US fall. This could perhaps be compensated with higher supplies from the US’ northern neighbour Canada and other countries. But what could seriously squeeze global oil supplies is a flare-up in West Asia.

If and when the Trump government reverses the previous US administration’s approach of reconciliation towards Iran, things could go awry. After the lifting of sanctions following its 2015 nuclear agreement with Western powers, Iran steadily increased its output; this added to the global oversupply of crude oil. On his campaign trail, Trump struck a posture of hostility towards Iran (also arch-enemy of long-term US ally Israel) but had given conflicting signals about the Iran nuclear deal. Ditching the deal will, however, be tough, with other powers such as Russia, China, Britain, Germany and France likely to push back strongly.

Even so, the risk of heightened stand-offs escalating into supply disruptions cannot be ruled out. Adding to the unease are Trump’s statements, made many times, once even after taking over as President, about how the ‘US should have taken Iraq’s oil’. Trump’s approach to the civil war in Syria and his perceived closeness to Russian President Vladimir Putin could also influence the price trajectory.

In 2002, former US Defence Secretary Donald Rumsfeld had used the term ‘unknown unknowns’ to refer to things ‘we do not know we don’t know’.

The world and the oil market, with another Donald as US President, may have to contend with many ‘unknown unknowns’.