OPEC: Time for a Petro-Euro?

June 2, 2015 - 0:0

As the OPEC meeting in Vienna approaches the oil market appears to be sending mixed messages. On the one hand the oil price has recovered from around $45/per barrel in January 2015 to over $65/bbl now – which appears to indicate a shortage of oil - while on the other hand many oil market observers see the market as being heavily over-supplied.

Meanwhile, according to news media the cost to use oil tankers are increasing, as more are being chartered to ship and store oil. The recent huge jump in daily tanker rates is due to more oil is being exported from OPEC countries.

Saudi Arabia is producing at its highest level in more than three decades. Iraq is poised to see a record high level for oil exports in the coming weeks, as it plans to boost oil exports to 3.75 million barrels per day in June.

Despite the ISIS crisis in Iraq according to observers those who have invested in producing oil in Iraq are able to pour an additional daily barrel of Iraqi crude oil into the global oil markets.

To understand the current oil market situation, I asked the oil market expert Chris Cook for his views of this apparent contradiction?

“There are now essentially two markets in physical crude oil. Firstly, there is the physical oil market, of oil for consumption, where oil is bought by refineries and processed into oil products. Secondly there is the financial market of physical oil as an investment. Here oil is being bought as a store of value at a time when conventional currencies such as the dollar are seen as risky and when interest rates at zero do not compensate for the risk of holding them. What we are seeing, and not for the first time, since a similar market event occurred in the first half of 2009, is an intervention in the physical market by a major financial buyer who by prepaying for crude oil is thereby funding crude oil storage.”

Who would do such a thing, and why?

Mr. Cook said: “The answer is simple......'follow the money'.”

This recent chart of Saudi Arabia's foreign exchange reserves tells the story.

Mr. Cook further explained: “Month to month increases and decreases in Saudi domestic expenditure at the magnitude of the reserve draw downs which took place in 2009 and in the weeks since January 2015 are extremely unlikely. In my view, what has occurred is a massive transfusion of Saudi funds into the oil market with a view to re-inflating the price.”

I asked why? Chris Cook replied: “If there is one thing that I have learnt in 30 years' experience of commodity markets it is that if commodity producers can support prices at high levels, then they will.”

I asked him to give me examples of such manipulation. He said: “This sort of manipulation of prices include a 30-year price support operation of the global tin market by a cartel of sovereign tin producers, and a ten year manipulation of the global copper market by the Japanese trading house, Sumitomo.”

Then during our conversation, I commented that in this way and as a result of the oil price increase of over $20/barrel since January 2015, Saudi Arabia benefits to the tune of over $200m per day on their 10m barrels per day oil production, to resolve their badly needed cash for currently daily expenditure?

I also pointed out to Mr. Cook that OPEC agreed at their last meeting to maintain production. The reason given was the aim to maintain market share by driving down the oil price to levels which would kill off U.S. shale oil production.

Has not this OPEC strategy been successful?

Mr. Cook smiled and in reply said: “Saudis may now earn $200 m per day to fund their badly under pressure budget. But, with regard to kill off U.S. shale oil production, I may say that on the contrary, it is the U.S. strategy which has been successful. This 'market share' argument is in my view an excuse given by Saudi Arabia to save face. From 2009 to late 2014, when the U.S. Federal Reserve Bank stopped the “Quantitative Easing” money printing which provided market liquidity, the oil price was supported above $80 per barrel, and often very considerably above. This high price, and the availability of cheap development loans, enabled the U.S. to create what is essentially a new – but high cost – strategic reserve of shale oil.”

Recent reports in the U.S. have revealed that crude oil production surged 300,000 barrels per day to 9.57 million barrels per day and set a new record for U.S. daily production.

So what will be the effect in the oil market?

Mr. Cook replied: “What has now happened since the collapse by January 2015 of the oil price to $45 per barrel (which I forecast in 2012 would occur once U.S. QE came to an end) is that the U.S. is now free, for the first time in 70 years, from reliance upon Saudi crude oil. I regard this new found U.S. energy security as perhaps the most important geo-political turning point of this century to date, with many repercussions.”

I said this is a fascinating theory, and asked him to outline why he takes this view, and explain the possible consequences.

Mr. Cook answered: “As is now widely known, the 'Petrodollar' was born in the aftermath of the 1973 Oil Shock when in exchange for U.S. support for the Saudi government, the Saudis agreed to sell oil in dollars and to invest the dollar proceeds in U.S. assets such as Treasury Bills. In mid January 2015, the European Central Bank announced that a program of Euro Quantitative Easing would begin within weeks. Since then we have seen the Brent North Sea crude oil price increase dramatically, and it became 92% correlated with the Euro denominated German government debt (Bund). There was also a major but temporary spike in the Dollar/Euro exchange rate which indicated a major flow of funds from the dollar to the Euro, and a temporary spike in the price of the Bund which indicated a massive program of purchases of the Bund, which is widely perceived as the safest of Euro investments.”

Well, very interesting indeed. But, I asked him again that, are you saying that the Saudis may have begun to switch their foreign exchange reserves out of Dollar and into Euro?

“Exactly so if, as it seems to me, the U.S. has indeed ejected Saudi Arabia from their tent, and then it makes complete sense for Saudi Arabia to regard their Petrodollar understanding with the U.S. as over. Moreover, the free Euro Quantitative Easting (QE) liquidity has been instrumental, when allied to Saudi finance capital, in re-inflating the oil price to the benefit of oil producers generally. ”

So, if this new observation is correct, then what would be best for Iran to consider? And how might this affect the Iran ongoing negotiations with P5+1?

Mr. Cook replied: “It appears to me that the principal difficulty for Iran is not the ending of physical sanctions, but rather the ability to access the proceeds of sale. I believe that major interest groups in the U.S. have it in mind to use the dollar payment system to hold Iran hostage for many years to come. So if Iran prefers to be masters of their own destiny then they would in my view be well advised to consider an immediate switch to a Petro-Euro.”

I asked him, what exactly he meant by that? Pricing oil sales in Euros; settling oil transactions in Euros or both?

He answered: “You are clearly familiar with my methods! I advocate that Iran should begin to price oil transactions in Euros, but as well as settling oil sale transactions in Euros, Iran might consider the supply of oil in an oil for product swap which could be priced in the Euro purely as a value standard.”

So, I responded by asking if he suggests that Iran should back a Petro-Euro?

He said: “Indeed so. I believe that the era of the Petrodollar is now at an end.