It hasn’t even been a week, but it’s already apparent that OPEC’s recent move to increase production won’t be enough to curb oil prices from climbing higher. Global benchmark Brent is already driving toward $80 a barrel again, and $90 oil is not out of the question in the coming weeks, with perhaps a push toward $100 before the end of the year.
Put simply, the more OPEC increases production, the less spare capacity the group has, leaving the oil market on a knife’s edge as it deals with a host of potential supply disruptions stemming from geopolitical and other issues. When oil markets set their sights on dwindling spare capacity, the result can be painful for consumers. Such concerns were behind oil’s record run to $147 a barrel in 2008.
The “peak oil” fears that drove that price spike don’t exist today, thanks in large part to the U.S. shale oil boom. But make no mistake, even with U.S. shale performing admirably this year and next, oil markets will remain volatile and subject to sharp swings based on headlines. Events over recent days show this clearly. The unexpected loss of 350,000 barrels a day of Canadian oil sands output for over a month, combined with the Trump administration’s announcement that it intends to use sanctions to drop Iran’s crude exports to zero later this year, has caused prices to surge.
This why OPEC’s vague agreement in Vienna last week looks destined to fall short. It effectively allows members in the OPEC/non-OPEC pact to make a notional increase of something less than 1 million barrels a day, but it’s far from certain how much physical oil will really be added to the market. Pundits put the figure at anywhere from 650,000 to 900,000 barrels a day. But no matter how you slice it, the perception is that the production increase may not offset decreases from troubled Venezuela, sanctions impacts from Iran, and the chaos engulfing Libya’s oil ports. Furthermore, the outage of Syncrude’s facility in Canada, much like the wildfires that hit that country two years ago, shows that non-OPEC countries are not immune to unexpected disruptions.
This is cause for alarm because of the limited amount of spare production capacity in the global system. Indeed, OPEC’s agreement to increase production was predicated on the group’s over compliance with its output deal due to involuntary cuts in countries like Venezuela, Angola and Algeria. The new arrangement allows for the few members with spare capacity – Saudi Arabia, Kuwait, the United Arab Emirates – as well as non-OPEC Russia to pick up the slack. U.S. Energy Secretary Rick Perry suggested that OPEC’s deal did not go far enough. The truth is that, given the limited spare capacity in the global production system, the cartel was in a no-win situation.
The International Energy Agency (IEA) estimates global spare capacity at between 3 million and 3.5 million barrels a day. The real figure may be considerably lower, but everyone agrees that the vast majority is held by OPEC heavyweight Saudi Arabia. In a 100 million barrels a day oil market, that puts Saudi Arabia firmly in control.
For the United States, that means maintaining good relations with the kingdom and consulting with Riyadh as an energy equal – thanks to the shale boom – on oil market matters. Saudi Arabia supports President Trump’s move to withdraw the United States from the Iran nuclear deal and reinstate sanctions on Tehran and its oil sector. The Trump administration sought oil supply assurances from Riyadh before the withdrawal, and the United States, along with China and India, openly complained to OPEC about rising oil prices ahead of the oil cartel’s June 22 meeting.
Saudi and U.S. interests appear to be aligned, but President Trump should reconsider his harsh rhetoric on Iran and his threats to reduce its exports to zero, as it spooks markets and causes prices to jump. Besides, no amount of tough talk is likely to get China, India or Turkey, which together buy around 60% of Iran’s oil exports of roughly 2.2 million barrels a day, to stop purchasing Iranian oil altogether. The president would also be wise to reconsider waivers for some buyers of Iranian crude among U.S. allies in Europe if oil markets become overheated. Reducing Iranian oil exports to 1 million barrels a day would do plenty of economic damage to Tehran, as the last round of nuclear sanctions demonstrated, without causing oil prices to spike.
Trump should also ease up on the trade front, as his aggressive policy is threatening to close export markets for U.S. oil and gas producers. China, the most coveted oil market in the world, had been importing growing volumes of U.S. crude before the trade row ratcheted up. Now Beijing is threatening 25% tariffs on U.S. crude. The president should also rethink his steel and aluminum tariff policy, which will raise costs on new projects at a time when the U.S. oil industry is seeking to expand domestic pipelines and LNG export facilities – both areas of infrastructure investment of interest to President Trump.
Lastly, the president should let it be known that he is not afraid to use releases from the U.S. Strategic Petroleum Reserve (SPR) if necessary to tamp down oil prices. Although Secretary Perry has publicly ruled out using the SPR as a “market manipulator,” believing it should only be tapped in emergencies, Congress has not shown the same discipline, using the reserve as a piggy bank when it suited them for budget purposes. Trump should keep the SPR option in his back pocket just in case. While SPR releases won’t go far in resolving structural supply-demand imbalances, they would send a bearish signal – even if temporary – to markets that Washington has options it can deploy if prices spike too sharply. Moving forward, sending the right messages to the oil market will be critical for the administration.
Dan K. Eberhart is CEO of Canary, LLC, the largest independent oilfield services company in the United States. He is a policy advisor to America First and a contributing writer to Forbes. This column originally appeared in Forbes.com on June 28, 2018.