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20 May, 2016 08:16

Oil output freeze now won't help anybody, OPEC already at max production – Ex-CEO of Shell

In the past few months, oil prices have been growing up. Experts say that hike is due to a firestorm disaster in Canada, as well as sabotages at Nigerian pipelines. However, these factors come and go, being only a temporary issue on the global oil market – so does that mean that the price will fall down again, plunging producer nations back into economic hardships? And that as OPEC fails to come to a consensus, as Saudi Arabia, a top player in the cartel, is unwilling to yield to Iran, which has just started to increase its output. Has OPEC lost its significance, and is living through its final years? And if that is the case, then what about America's shale companies – is there still a chance for them to come back to the world market? We ask the former head of Royal Dutch Shell. Jeroen van der Veer is on Sophie&Co today.

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Sophie Shevardnadze: Jeroen van der Veer, former CEO of Royal Dutch Shell corporation, welcome to the program, great to have you with us. So, Wall St. heavyweight Goldman Sachs is saying that after several years of oversupply, the crude market is now experiencing an oil deficit. However, they said a completely different thing a couple of months ago - how do we  go from oversupply to deficit overnight?

Jeroen van der Veer: Zdravstvuite. Well, the situation on the oil market is that the overall production is only 2% compared to demand. So, if our estimates are only a bit wrong, then you are suddenly either in oversupply or shortage. So, it’s a very tiny balance.

SS: But, you know, a lot of experts are actually citing wildfires in Canada that disrupted oil production, also, a pipeline bombings that are crippling oil production in Nigeria as one of the possible reasons. But, all this will pass: fires can be put out, pipelines will be repaired. But, will all this have a lasting effect on oil prices?

JV: There are always disturbances. But, the best way to say it, the production in the world is 94 million barrels per day, demand is 92, so the whole balance is oversupply for 2 million barrels per day. So, indeed, if you have some large outages, then indeed the price may react, but there are a lot of factors which are very difficult to forecast. For instance, what will be imported via China, how fast is the economy in India growing. So, it is not just technical outages, it is simply you try to forecast something which is very sensitive to the outcome.

SS: So why do you think the price is rising again, while Iran is increasing production after years of absence on the market? Why isn’t Iranian oil filling the void made by recent disruptions?

JV: I think that we have to realize that in fact all countries produce to the maximum or very close to their maximum. So, they can’t produce more. But that sum, together is just a bit more than the world demand. So, the world, they realized in January, when the oil prices were as low as $30 per barrel, I think it took a bit of time in the world that overcapacity was only a tiny bit.  so, indeed, if you have outages or if the OPEC would succeed in working together to constrain production, then you will see a very strong price reaction. The oversupply has never been that much. Having said that, if you oversupply, you have to store it somewhere, and that’s why you see that storage is now full and there’s a lot of floating storages and tankers, and, of course, if oil prices go up, that kind of storage may become available to the market, so that’s why I expect the markets not go that fast, only slowly.

SS: But also, when I look at it, it does seem like we’re going in circles. Let’s say, there’s indeed a deficit. Will the pendulum swing the other way soon, as soon as the companies rush to utilize improved prices and producing too much and creating oversupply again?

JV: Two things can happen, that you go for a real shortage. The first thing that may happen  - if OPEC succeeds to constrain production, and this was, like, so many years ago, they did that before, and of course, the world has to think: “Do we trust that if they say they will cut production, that they do it as well?” - but that’s the first possibility. The second possibility is that demand will get bigger, whilst new supplies will not come onstream. In fact, that may happen, say, two years out  - why is that? Because many investments in new oil fields have been canceled and as you know, oil fields will run out. We call it a “cold way” or a “tough way”, but it will take some time, but then if you don’t bring new supplies onstream, whilst the demand is ongoing, then you’re going to get a shortage. My best guess it will be two years out.

SS: Also, a number of U.S. shale companies halted production due to low prices, but with price climbing back up, they will surely be back in business. Obviously, once they return to pumping, the price goes back down and they close again. Does this mean there’s no way for U.S. shale producers to maintain a share of the market?

JV: I think that those shale producers for oil who can produce cheaply, they either have continued or they will restart. But, that may be a swing in total, say, of half a million barrels a day on the total production of 94. Yes, it is relevant for the U.S., but it is still was in the large shrinks of demand or in the potential producing outages, as I’ve just described.

SS: Right, but I’m just talking about the shale producers, and their future on the market. Is there a place for them on the market, considering that, you know, once the prices are up, they start pumping again, but then they will have to close down again because no one will buy their oil. Do you think they can maintain a share of the market, the U.S. shale producers?

JV: I think, especially with the agility of Americans, they will try with the help of technology, productivity improvements, they will try to produce shale oil for a relatively low costs. So, those who have good anchorage, where you can indeed produce at low or modest cost, and they will continue to produce and if oil prices are good, they will produce more, and if the oil prices are low, they will produce a bit less. This too, reveals that they adapt itself all the time to the oil price, but there will be, in the end, quite a flow of shale oil coming for the American market.

SS: Lower demand from China has also influenced the oil market, but right now China is stockpiling oil at the record rates. Will the oil price be hurt when China’s stores are filled up?

JV: Nobody knows exactly how large this storage is. Many people have expected that by now, due to the oversupply, the would run out of storage. In the beginning they were storing, of course, in normal storage tanks, then people started to hire supertankers, floating storage, later even smaller ships, even rail tracks - and there may be possibilities for underground storage. Probably there’s more storage capacity in the world than people realize. And, of course, having a lot of storage cushions the oil price. What I don’t know as well is present oil price, having reached already close to $50 per barrel now, will the Chinese continue to buy, because they consider this still as a low oil price, for storage, or do they think “enough is enough”. Hard to say, but all those aspects will impact the oil price.

SS: Now, just weeks ago, there appeared to be no other option to prop up oil prices other than freezing oil output. But, right now, the price is going up without any OPEC intervention. Is the production freeze still on the cards?

JV: We have to realize that everybody, including the OPEC countries, they produce more or less to the maximum. So, if OPEC freezes, that basically means that they will freeze at a maximum. In itself that is not a reason for a relatively fast price increase. Then they have to say “we have to cut production” - and then they have to say, for instance, “we cut production by 5%”, or 10%, and then people have to believe if they say they’ve cut production, that they will do it. If the last part will be the case, then you will see a strong price reaction. So just freezing is, basically, just a status quo, which close, or, in fact, an oversupply situation.

SS: Iran’s oil output is increasing at a rapid rate, and it’s already close to 4 million barrels per day - pre-sanction benchmark. This is what Tehran wants to reach before considering joining the global production freeze. Will the Iranian accept an OPEC-led freeze, if it’s agreed on in June when the cartel meets again?

JV: Iran, the quantity of oil they produce now was about the levels of the past, or even a bit higher. Of course, during difficult years, with the sanctions on the Iranians, all production went down. Now, they have to rebuild their country, they need a lot of investment, investment for their economy, investment to further increase their oil production as well - so it makes sense that their oil production, compared to year ago, that they would like to increase that considerably. They have done the easy part, for which they don’t need that much investments, now for further increase they need more investment, and if I would’ve been an Iranian, I would say that “It is fine if other countries freeze, but Iran is in a special circumstances, and by the, we were a larger producer in the past.” So, I can see the logic, and I don’t expect that they will consider freeze compared to their oil production so many months ago.

SS: Also, it looks like Saudi Arabia doesn’t really want an output freeze or a cut. Does it?

JV: Now, Saudi Arabia is producing close to their maximum. Geopolitical tensions between the Saudi Arabia and Iran may play a role here as well. I think freezing doesn’t do the trick, so it’s more like making noise and trying to put pressure on other people, but if everyone produces to the maximum, what is a freeze? The only thing that may affect the price is that if people start to cut production.

SS: Now, the Saudi Arabia’s oil overproduction is aimed at securing its share against Iran’s return to the oil market. What will the current, higher, prices mean to the Riyadh-Tehran market battle? Will it only grow more fierce?

JV: Now both Saudi Arabia and Iran, their production cost for oil is significantly lower than $50 per barrel. So, both, at present oil prices, they can be profitable. The difference is that Saudi Arabia, they are producing at this moment 11 or 12 million barrels per day - that is above their maximum. Iran, they have underinvested over the past years so in order to get their production higher than 3,5 or 4 million barrels per day, they need to have investments, they have to do investments, and that takes time. Having said that, those investments will be, at present oil prices, profitable, and then one has to realize that Iranian economy, with 80 million people is a fast-growing economy. So, domestic demand for oil will grow up quickly as well, so one has to see that even if Iran increases oil production, only a part of that will be for export, and that part of course may have an impact on world oil prices.

SS: Saudi Arabia has also seen a major cabinet reshuffle which replaced their Minister of Petroleum with Saudis Aramco CEO Khalid Al-Falih.. Does this mean Saudi Arabia is changing its oil strategy or no?

JV: I don’t expect so. One has to realize that Minister Ali Naimi was not only minister but he was for many years the Chairman of Saudi Aramco as well. Khalid Al-Falih, the newly appointed minister was the CEO. So, those two worked together for many years, and I think they are, so to say, out of the same school. So, what I expect - yes, there’s a switch between ministers, but I expect that their present policies will continue.

SS: Also, former Eni CEO Paolo Scaroni told me in an interview that OPEC needs to cooperate with Russia to maintain its power and influence on the oil market - and yet Russia hasn’t even received an invitation to the upcoming OPEC meeting in June. Why not? Do some OPEC members want to decide things without Russia? What’s your take?

JV: If you look at the big picture, the world oil production 94 million barrels per day, OPEC is doing a bit more than 30, and Russia is doing about 10. So Russia, in the total world balance, is more than 10% of oil production - so they are a very large player. Now, if you would like to constrain production in a certain way, then of course you would like to have all the big players at a table. So, that is the reason for OPEC to invite Russia, and that, of course, they would hope that if OPEC would decide something, that Russia would fall in line with that.

SS: Tensions grew during the recent meeting of OPEC officials, with one of the delegates proclaiming OPEC as “dead”. Since it has practically stopped existing as a unified organisation - do you see it collapsing completely?

JV: I think it is quite clear that a number of OPEC members, especially those where the production costs are significantly higher, or where you have governments which need to have a lot of oil income for their economy - that are most unhappy with the present policies of OPEC. They are of the school that there should be the cut in production, especially by the large producers, so that a state income is better. So, you can say that there’s a lot of quarrels and disagreements going on in OPEC, but that may be the case for one year, two years, forever - nobody knows. I think it is quite remarkable so far that they haven’t made any progress as members together. So, in short-term it will be very difficult for OPEC members to come to a kind of consensus, which is different from producing to the maximum as they do now.

SS: But OPEC was designed to control oil prices, and now it’s failing to do that. What is the use of the oil cartel right now? What’s the purpose of OPEC right now?

JV: I think the interests are too different. Think about Saudi Arabia. They have oil for hundreds of years, they are the lowest cost producer -and then think, “ok, normal economic terms is that the lowest cost production is the most profitable, you that first”. Then, why would Saudi Arabia, they think, “Why would we cut our production a lot in order to help those countries who have indeed very expensive production to break even?”. Every time they are not prepared, OPEC members, in the past, outside Saudi Arabia, were hardly prepared or not prepared at all to cut their production. So, Saudi Arabia was in fact the only OPEC member who was playing ball, so to say, in cutting production and helping all the others. Now, one day, the Saudis said: “Enough is enough, we have to do it all together, we don’t all the burden on us - and you see what happens if we continue to produce, and by the way, low oil prices is in our own long term interest with Saudi Arabia So, you, other countries, you sort it out yourself what to do with your oil, but we are in the strong position.”

SS: Now there’s this debate going on for a while - whether cheap oil is good for world economy or not, because China’s economy, European economy, Japanese economy, even the U.S. economy are happy with cheap oil, right? While oil-exporting countries are suffering, Venezuela is on the brink of collapse, Russia, others are experiencing difficulties - so, what is better for the world economy? Cheap oil or expensive oil?

JV: This is a very good question, but let me take it in a different way: if oil prices would have been for a very long period, say, $40 per barrel, and then oil prices would jump to $100 per barrel, all the economists will write: “Oh, this is a disaster for the Western world, we got recession or worse”, blah-blah-blah. Now, the other way around, there must some truth in that - if oil prices were for a very long period, say, $100 per barrel, and say, over the past year, I don’t know exactly, $40 dollars per barrel - that is an incentive for the world economy. However, economic growth in the world, I expect indeed to go faster with low oil price than the opposite.

SS: A mysterious militant group has been attacking Nigeria’s oil infrastructure, blowing up pipelines, forcing multinationals to halt operations - is oil production sufficiently protected against terrorism around the world? Are multinational corporations going to leave every time there’s a threat against them?

JV: Producing, especially, on shore or in the delta of Nigeria, is very difficult. I think both the oil industry and the government, they learn all the time to better protect it. There’s many poor people and people complain that they hardly or no profits of the oil industry, and at the certain moment they fight with their feet,  or they fight with sabotage. This is a huge problem which changes all the time. You can only come to solution by cooperation with the government, because the government is there for the security of the country, the oil industry - what they can do - and, of course, the local people, to make them see that sabotage is not a win-win situation. It is a very complex situation, and I hope that positive progress will be made soon.

SS: Chapman House think-tank is saying international oil companies like Shell and BP must change their strategy or face a brutish short-end within ten years. What’s going to happen in the next decade? I mean, you were a head of Shell, you know how this works, what’s wrong with oil companies’ strategies at the moment?

JV: I’m now involved in the world economic forum and we look at the long-term future of oil and gas, and then we look at all of the scenarios, we look at the scenarios made by oil companies, we look at scenarios made by NGOs, and then you see a picture, that, long-term, what could happen: most of the oil will be used for transport fuel, but even if the number of passenger cars double, than if miles per gallon will double as well, so cars get twice as efficient, then the quantity of transport fuel will be same as today. So, what you will see, that in spite of increased number of passenger cars, long-term, the quantity of oil used for transport may go up only slowly; and secondly, one has to factor in that we have electric cars, and we may have more cars on natural gas, so we have to look at that. So, oil will basically be roughly as far as I can see now, at present quantities in the world, 30-40 years out, or even a bit declining, whilst total entity in the world will go up - more middle class,  more people - so it means, indeed, that the market share of oil in the total energy mix of the world will steadily decline. And, by the way, 10 years ago, oil was 40% of the energy mix in the world - we are already now at 31%, and say, 30 years out, it may even be below 20%. But then, there’s still oil to be consumed, especially for transport.

SS: Thank you so much for this wonderful interview. We were talking with Jeroen van der Veer, former head of Royal Dutch Shell, discussing the turbulent price of oil and its economic and political influence on the world. That’s it for this edition of Sophie&Co, I will see you next time.