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8 Feb, 2016 07:26

Fair price for oil is $130 & will be, despite Saudi attempts - World Bank consultant

With oil prices at their lowest point, nations relying on oil are suffering - and it's not just Russia and Venezuela. Even OPEC members are in trouble, despite having the power to change the balance on the market. But they have been unable to reach such an agreement - at least up until now. With rumors of OPEC finally deciding to cut production, will the oil market rise again? And why are Saudi Arabia and the Gulf nations, now being forced to cut spending, persisting in their position on the issue? We ask international an oil economist and a World Bank consultant. Dr. Mamdouh G. Salameh is on Sophie&Co today.

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Sophie Shevardnadze: International oil economist, World Bank consultor, Dr. Mamdouh G. Salameh , thank you for being with us today. So, doctor, Saudi officials have denied reports that OPEC has offered a 5% oil production cut; however, there are signal coming from Riyadh and Baghdad that they are ready to accept the cuts, if OPEC agrees on it. Iran is not planning any cuts in the near future, and then you have President of Venezuela, an OPEC member, saying that world's top oil producers are close to forging a deal to restore oil prices. So, who are we to believe, who is bluffing here?

Mamdouh G. Salameh: There's no smoke without fire. Certainly, there has been a lot of reports about possible agreements between OPEC members and Russia about cutting oil production in order to bolster the oil price. Of course, OPEC waits for Russia also to help, but the fact remains that OPEC was responsible in the first place about the glut in the market, because its members have been producing 2.2 million barrels a day above their production sealing. So they have a responsibility towards the oil prices and towards their members to cut production. I am sure that if they do that, Russia will match their cut, but they are using, possibly, half a million barrel a day to support the oil price.

SS: So do you think there will be a 5% cut or not?

MS: I am sure they are heading that way and there will be a cut, because I can tell you that even the very rich Saudi Arabia is suffering. It's economy is suffering from the low oil prices and its currency is coming under heavy pressure because of the low oil prices. So, Saudi Arabia is going to help cut the production.

SS: We're going to talk about Saudi Arabia a bit later, but let me ask you this: the whole point of OPEC is to ensure stability for the oil markets, but it appears to have been failing to do so in the past year. Has OPEC lost its grip, or is it doing this on purpose?

MS: There's no doubt that OPEC has lost some of its influence, but it is still a powerful organisation. They account for 41% of global production, which means a lot to the oil price and to the global oil market. However, it seems that under pressure from Saudi Arabia, OPEC has deserted the production quotas. And, of course, we know that that is part of Saudi Arabia oil policy, which is to pre-empt the return of Iraq and Iran in a big way into the global oil market. Saudi does not want to lose market share to its rivals, particularly Iraq, which is able to raise its production in a very significant way. As for Iran, it is difficult for Iran to raise its production even after lifting of the sanctions.

SS: Dr. Salameh, we're going to get to Iran a little bit later, but Saudi Arabia has always played the role of the swing producer in OPEC. But so far, it's been refusing to cut oil output and that's despite pressure from other members. Is it calling the shots in OPEC? Has OPEC become a one-man show?

MS: As it is now, it seems so. Saudi Arabia is OPEC, and Saudi Arabia is the decisive force in OPEC. But, Saudi Arabia has different thoughts about oil and oil prices. It seems they are following the oil strategy intended to harm Iran's economy as well as to try to slow down if not undermine the production of U.S. shale oil; and, of course, pre-empting Iran and Iraq asking for bigger quotas inside the OPEC.

SS:Let me ask you this: if this Saudi policy is aimed against Iran - it doesn't seem to be working, exactly, because Tehran is doing okay, upping its production and it shows no sign of breaking down. Why persist?

MS: It didn't work, it was intended initially by the U.S. and Saudi Arabia, in a sort of political conclusion against Iran and against Russia. It didn't work in both cases, but they don't want to lose face and reverse their policy. We know that Saudi oil policy of flooding the global oil market with a lot of oil has been tested under Sheikh Ahmed Zaki Yamani, the former Saudi oil minister in the early 80s, and proved wanting... But, it seems that they are repeating the policy which has proven its failure. So, sooner or later, and with the pressure under only-oil economy of Saudi Arabia, they will have to reverse that policy, where they like it or not.

SS: So, this Saudi desire to bring Iran down - is it worth the economic fallback for Riyadh? You just said that their economy is already suffering. According to data compiled by CNBC  - Saudi Arabia may go bankrupt as early as 2018 - if the prices stay this low.

MS: Well, the IMF has warned that if low oil prices prevail for the next few years, Saudi Arabia would have used all it is financial reserves of 5 years. So, in 5 years time, like, by 2020, Saudi Arabia will not have any financial reserves to support itself...

SS: So that's why I am asking: is this quarrel really worth an economic fallback that big for Riyadh?

MS: Really, it's a political decision. They have given more weight to political decisions rather than the economic decisions. They cannot accept that that policy has failed. But, as I said, because they cannot accept that, their economy and their currency are suffering. Sooner or later, they have to realize that they have to cut their losses and reverse that policy and be part of OPEC and accept a cut.

SS: I am thinking, it's not just the Saudis, because the economies of all Gulf petrol states are dependent almost entirely on oil. What are the risks of the oil price being low for them and since their budgets are already being cut, will the population grow restless? Is it dangerous? I mean, Arab spring was just around the corner from them...

MS: Yes. The question is the low prices has affected everybody: from the global economy to oil producers around the world: The U.S. shale oil production, even the rich members of OPEC, like Saudi Arabia, UAE, Qatar, Kuwait - all these countries, their budgets are dependent on the oil revenue to the tune of 85-90%. So, as I said, that policy of flooding the market under pressure from Saudi Arabia has failed and they are now realizing that that policy is actually damaging their economies. Testimony to that is that they are cutting the subsidies which their people enjoyed for many-many years: subsidize for gasoline,  diesel, water and electricity, and they are taking so many measure as well - like, Saudi Aramco is considering selling some shares. That would have been a science fiction a few years ago, but now it's becoming a reality and the Deputy Crown Prince of Saudi Arabia has said in an interview with The Economist magazine that they are considering that. He confirmed, and he said that not only Saudi Aramco but other government-owned companies will be subject to share sale.

SS: Okay. Now, let's look at the other side. Countries like Iran and Libya are against curbing their production, and they're saying they need higher output levels to make up for years of wars and sanctions. Are those fair demands? What can make them change their mind?

MS: It is irrelevant. Let's take Libya, for instance. Libya has become a footnote in the history of oil production, because until there's peace in Libya, there's no way Libya can go back to producing 1.6 million barrels a day as they used to do up to 2011. Now they are producing less than 300,000 barrels. They are hardly exporting anything, or, in fact, they're not exporting anything, and what they are producing is hardly enough for domestic consumption. So, you can put them for the next few years on the margin, simply because that has to wait for a political settlement. As for Iran, Iran currently produces around 2.7-2.8 million barrels. When they say they don't want to accept any cuts - they are right, because their quota in OPEC is 4 million barrels a day. They have never achieved that quotas since 2000, and now they are producing far less than that. So, that's irrelevant whether they accept or not.

SS: Venezuela's President Maduro has also said that a fair oil price would almost amount to $60 a barrel. Is that the case, or the current price actually reflects the real value of crude?

MS: Well, for the time being, it's okay if we can achieve it, shortly, provided OPEC cuts production. However, in my opinion, a reasonable oil price for the global economy, to encourage investment and expansion of production is $100-130, because the global economy can absorb that price easily, because we don't have to look only at the price as such - we have to look at the fact that the oil companies, the global oil sector, needs the price of $125-135 a barrel to balance their books. The major seven companies in the world need that price. They are already cutting their investment globally, and their expenditure and they are making thousands if not hundreds of thousands of people redundant. That is undermining the global economy - and of course the economies of the oil producing countries. So, we need a very reasonable price, and in my opinion, the price should be between $100-130 a barrel to give the global economy the incentive to invest heavily and globally.

SS: But is that a realistic price? Do you think we will ever see oil go up to $125 again?

MS: It will, eventually, because, if you look now, even if the price is around $33, to the fundamentals of the global oil markets, the fundamentals are positive, meaning that, according to the World Bank and to the IMF, it is projected that the global economy will grow this year at 3.5% and furthermore, the IEA in Paris has indicated that this year, the global demand for oil is growing at 1.4% or 1.5 million barrels a day. Even China, whom they say, their economy is slowing - well, their economy grew 7% in 2015 and is projected to match this, or a bit less, this year. So, they are a far bigger economy that they were in 2007, few years ago. So, all the fundamentals are positive, so that should be reflected in the higher oil price, even if OPEC does not cut production.

SS: There's a lot of talk about Chinese economy slowing down, you know, and this could also drive the demand for oil down: however, China is still buying a lot of oil, record amounts. So, the fears of China recession and its effect on commodity - is this all exaggerated?

MS: It is very much exaggerated and it has been played up so much, especially by Western media. China is still importing oil in increasing quantities, not only for their own consumption but for their strategic reserves as well. As I mentioned, China's GDP now is 3 times what it was in 2007, eight years or nine years ago. So, there's only one way for China's demand for oil and that's upwards. That's why I am saying it is politics that are affecting the oil price and not the fundamentals of the oil market.

SS: So, will cheap crude actually help the monster economies of China and India regain growth, demand more oil, thus driving, maybe, the prices back up?

MS: Of course. Of course. There's a correlation between economic growth and demand for oil, even with the rationalization of the use of oil, and when the economies of these countries start to show improvement, of course, the demand for oil will increase. Not particularly for the European Union, because they are... it has plateaued, virtually, their demand for oil, has plateaued but for the Asia-Pacific region, in particular, and the developing countries around the world, the demand for oil is growing, and that should be reflected in higher oil prices for many years to come.

SS: Another huge topic that's affecting the prices, is, of course, the U.S. shale oil and its shale oil producers have been flooding the oil market with up to 9 mn barrels a day, contributing to the global oil price fall. Like you've said, Saudi Arabia is refusing to cut production, to keep its place on the U.S. market, and therefore, draw American shale oil out of business. If that's the case, are they succeeding? What do you think? The number of oil rigs in the U.S. has more than halved in the last year.

MS: It is not Saudi Arabia of OPEC who are adversely affecting U.S. shale oil production, it is the oil prices.

SS: Yeah, but the oil prices are directly linked to what Saudis are doing in the region...

MS: That is true, but the question is neither Saudi Arabia or OPEC could kill the U.S. shale oil production. What will kill U.S. shale oil production in the long term is geology and debts. As you appreciate, a well of shale oil production loses 72-90% of its production in the first year, in comparison with the conventional oil. Of course, shale oil producers are depending on debts. They already have $200 billion in debts and with the rise of the interest rates in the U.S., they will find it difficult to pay to interest on that. That's why many shale oil producers have gone bankrupt - but the question remains that when the oil price starts to go up, shale oil will be back, but with not such of a quantity that will affect or cause glut in the market. What will cause glut, always, is OPEC producing over their production ceiling and that is the case.

SS: But talking about the shale oil production what you've just described, how long before that actually happens?

MS: We have seen shale oil production has lost 600,000 barrels in 2015, and if the low oil prices continue, they are projected to lose another 900,000 barrels this year. So, the shale oil production is suffering, but then, not only the shale oil is suffering. Saudi Arabia and the Gulf region is suffering. Russia is suffering, the global economy is suffering. Every oil producer is suffering. That's why I am saying that it is up to OPEC to decide and to accept that shale oil production is a fact, and they have to deal with it as a fact. When the price goes up, shale oil will go back, but not to threaten a glut e market. America is still importing 7 million barrels a day, despite the fact that they are producing shale oil.

SS: Here's another interesting topic: global oil producers are actually running out of space to store all the oil surplus they have, moving the commodity to be stored in tankers at sea - is there nowhere to sell all this oil? Are traders stockpiling the goods to sell them later, when the price goes higher?

MS: Well, they sell when there's demand for oil and I think there's demand. The part of the low oil price is that some of this stored oil is seeping to the market. But, the amount they are storing is not that huge. I know, the storage in America has reached the top now, and there's no other way except to plateau or start to decline. But, when the prices improve, I am sure, those who have some stored oil will introduce it to the market, but the effect of that introduction on the oil price will be short-lived and limited, because no matter how much you store, you are producing what you can produce, and you are selling most of it at low oil prices, so what is stored is very limited world-wide.

SS: You know, one refinery in the U.S. is already buying oil at a negative price - that is, it gets paid for taking surplus oil off the hands of producers. Is that the consequence of the low storage space available? I mean, what's the point of producing oil if you then have to pay someone else to buy it?

MS: There are reports like that about American refineries, but you appreciate also that American refineries are limited, they are configured to use medium and heavy oil imported from around the world, that's why the Americans now are trying to sell a bit of their ultra-sweet oil to refineries in the Asia-Pacific region and Europe where it can be refined, and they are importing an equivalent amount of medium and heavy oil for American refineries to use: but you need a lot of infrastructure inside the U.S., like pipelines, to carry the light oil, very light oil into these refineries, and that will take many years to become operational. That's why America is trying to sell or export a bit of its very light oil, and import equivalent amounts to use in their refineries.

SS: Dr. Salameh, thank you so much for this insight. We were talking to Dr. Mamdouh G. Salameh , international oil economist, a consultant on energy issues for the World Bank, discussing the oil price drop and the effect it's having on the world's economic and energy landscape. That's it for this edition of Sophie&Co, I will see you next time.