Syria Diplomacy and Oil: Geopolitics May Change Oil Outlook Dramatically Again

As the U.S. Congress gears up to debate the merits of the nuclear deal signed between Iran and the P5+1 powers last July , the Obama Administration is working overtime to get Mideast diplomacy off the ground to prove that the politically controversial deal is paying the way for a better Middle East. The effort, if successful, could have large implications for global oil markets, now facing a major price collapse.

Last week, a flurry of activity including high level meetings between Russian and Saudi diplomats, Iran’s foreign minister Javad Zarif and Syrian President Bashir al-Assad and Iranian and Lebanese officials (http://www.aucegypt.edu/GAPP/CairoReview/Pages/articleDetails.aspx?aid=871). The blogosphere was buzzing with rumors, including one that Riyadh and Tehran are agreeing on a formula that would restrict Hezbollah back to Lebanon, cordon Bashir al-Assad off to a limited titular role and begin serious negotiations for an inclusive political transition in Syria. (http://www.timesofisrael.com/irans-syria-plan-hezbollah-withdrawal-assad-as-toothless-leader/) One report on the deal purports an Iranian proposal that encompasses a cease fire and full-scale, free elections in Syria. ( http://www.al-monitor.com/pulse/originals/2015/08/lebanon-iran-zarif-visit-messages-implications-repercussions.html#) Russia added to momentum to positive prognostication when Fyodor Lukyanov, chairman of a council that advises the Kremlin on foreign policy uttered a more lukewarm support for Assad in an interview with the New York Times, proclaiming “Saudi still believes that Assad should go, but now they are a little less sure that the alternative will be better…Russia still believes he should stay, but cannot ignore that the general situation is changing, that the strategic position of Syria is much worse now than before.” (http://www.nytimes.com/2015/08/12/world/middleeast/new-diplomacy-seen-on-us-russian-efforts-to-end-syrian-civil-war.html?_r=1) But today’s rhetoric out of Russian-Iranian public announcements is unchanged in rejecting calls for Assad to step down as the head of Syria so hard to know if a meaningful deal can really be achieved. Zarif said at a press conference in Moscow, “The Syrians must themselves decide their fate, their future, while foreign states should only make this easier.”  (http://www.rferl.mobi/a/27192710.html) To date, the complex conflict has defied any and all attempts at a peace conference or cease fire.

From the United States point of view, positive movement on the Syrian front would permit a very key development. Turkey, Saudi Arabia, the United States, Iran and Russia could all come together in a concerted effort to stop the Islamic State (ISIS).

But for oil markets, most interestingly, it would lay the groundwork for Saudi Arabia and Iran to work more cooperatively inside the Organization of Petroleum Exporting Countries (OPEC). A surprisingly resilient U.S. oil production from shale, combined with the cloudier outlook for China’s economy, means OPEC would have its work cut out for it to bring prices back to the lofty levels seen in 2014. Analysts agree that a Saudi gesture to pull back its high production would at least give markets reprieve from the current free fall. Sources say Saudi Arabia may be inclined to consider an OPEC floor price $60 to $65 a barrel, were Iran’s actions in Syria demonstrate a serious commitment to a peace process. Any Saudi move would likely require real progress on the ground in Syria, not just on paper.

So far, oil markets are ignoring signs that diplomacy is intensifying. Instead, “lower for longer” is becoming the catch phrase for 2016 and puts are being placed at $35 a barrel West Texas Intermediate, now that  $45 has been breached. The International Energy Agency (IEA) reported last week that despite strong demand, the oil market oversupply will extend into 2016. The IEA revised its demand forecast for 2015 upwards to 1.6 million b/d but said that an overhang of 3 million b/d of oil will persist into the first half of 2016. The IEA report said non-OPEC oil production is still on the upswing of over 1 million b/d, though down from last year’s 2.4 million b/d.

For U.S. shale producers, the summer oil price downturn will test abilities to cut costs. There seems to be no end of investors willing to throw a few more dollars at shale oil producers. Financial markets and private equity firms still have an appetite for corporate bonds and other facilities on offer to cash in ahead of the expected rebound in oil prices, whenever it happens. Rather than the wave of bankruptcies predicted if oil prices went below $50 a barrel, shale producers still seem resilient, saying that they can keep going given hedges and rising productivity.

There seems to be some evidence that experienced wildcatters, figuring $100 oil would never last, had produced some of the more marginal acreage first, and are now, given oil price pressures, shifting to areas where unit costs can be better controlled. All this will mean that even if Saudi Arabia and Iran can reach a truce in Syria that holds, OPEC will still have its work cut out for it in fashioning a production quota sharing deal that will move prices back to target levels this year. The producer organization may have to position itself in a more forward looking, longer term strategy to capture market share when the supply hole comes from tightening budgets for oil sands, Arctic and deepwater drilling in the next three to five years.

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