Business
Trump must hope shale producers can continue to spring surprises
By Juliet Samuel, Telegraph, 14 May 2018
May 15, 2018 - 4:07:26 PM

Don’t panic – or, don’t panic yet. Oil markets absorbed Donald Trump’s decision to withdraw the US from the Iran deal without a huge shock last week. Brent crude jumped from around $74 to $77 a barrel, after the president chose one of the harsher of the options that were available to him.

But Trump’s decision could hardly have been a surprise. The bigger shock is yet to come – but markets are remarkably sanguine about it.

It’s been a while since oil prices jumped around purely on the basis of geopolitics. Over the last five years, market watchers have focused instead on the tug of war playing out between US shale producers, who keep surprising the world with their adaptability, and Opec, which finally managed to agree on production cuts last year and has largely stuck to them. As a result of Opec’s renewed discipline, Brent crude has risen steadily from $50 a barrel to around $75 in the past 12 months.

Opec needed to do something. Ever since US shale producers burst on to the scene in 2014, the cartel had struggled to cope. Saudi Arabia decided it was a good idea to give the Americans “a good sweating” (as Rockefeller used to say) by stepping up production and cutting prices. At the time, US shale was high cost and looked fragile.

I remember former BP boss Tony Hayward telling me confidently in 2013, when Brent traded at over $100 a barrel, that $50 oil would wipe out much of the burgeoning American oil industry and send prices right back up again.
"Over the last five years market watchers have focused on the tug of war between US shale producers and Opec"

But against expectations, the shale producers knuckled down and slashed costs. They began producing so much oil and gas that the US government lifted a 50-year ban on exports and their oil tankers started to fan out across the globe. Amazingly, the US is now expected to become a net oil exporter in the next 10 years. Faced with this unprecedented new disruption, Opec cooperation broke down and oil plunged.

Budget deficits soared in Russia and Saudi Arabia, and Venezuela tumbled into riots.

Inflation figures in Europe and the US dropped, despite the continued easy flow of money from the central banks, and consumers enjoyed a much-needed boost to their household buying power.

All good things come to an end. Opec finally got its act together last year, production began to fall, global oil inventories started to run down and prices began to march upwards. And now, along comes Trump.

The direct effect of his Iran decision is fairly negligible. Iran still hadn’t managed to boost its presence in oil markets massively even after the deal came into effect. Even with the US sanctions back on, it will still be able to sell its oil to Asian markets.

The international investment it needs to raise its production significantly in the long-term has been slow in coming, precisely because of the geopolitical risks.

But the knock-on effects could be significant. The White House, sensitive to the impact that any oil price spike could have on US consumers, especially ahead of the midterm elections, claimed that it had assurances from friendly producers that they would make up for the shortfall caused by Iran. This is a short-term solution.

For one thing, it isn’t in the interests of Opec producers to dampen down prices by much. Saudi Arabia might want to help out the US and be supportive of Trump’s tough stance against Iran. But it also needs oil to go higher to pay for its enormous economic reform programme and to ensure it gets a good valuation when it floats Saudi Aramco, a deal now slated for next year. The rumour mill has it that Riyadh wants to see prices stay up around $80 a barrel. If that’s the case, it’s unlikely to be arguing for Opec to change course.

More importantly, however, tensions are rising in the Middle East. Israel has stepped up its bombing of Iranian targets in Syria in an attempt to stop Iran shoring up its strategic gains from the Syrian civil war. A recent election in Lebanon gave a boost to Hizbollah, the Iran-supported militia, which is overseeing a massive military build-up on Israel’s border. The Gulf States share Israel’s concern about an ascendant Iran and have enthusiastically supported the White House’s harsh stance.

John Bolton, Trump’s new national security adviser, has long believed that the US should actively support regime change in Iran. Withdrawing from the nuclear deal in order to increase economic pressure on Tehran is part of the strategy. If he gets his way and manages to destabilise the country, there’s a strong chance the regime will lash out.

That could mean restarting its nuclear weapons programme, attacking Israel or threatening to blockade the Straits of Hormuz, one of the oil market’s most important trade arteries. All of this suggests that we could be in for a prolonged period of higher prices, or a shock, rather than a return to a benign, lower-price period.

Not everyone thinks so, of course. BP boss Bob Dudley said his company is still planning on the basis of $50-$65 oil. Others think that US shale producers will keep plugging the gap.

A rising oil price is the last thing the global economy needs at the moment. The effect on inflation could force central banks to raise interest rates faster than they’d like, even as we’re more indebted than we’ve ever been.

Some investors are starting to talk about the cycle turning, with increasingly silly prices being paid for assets and borrowing discipline going out the window. The risks are building. The US had better hope that its shale producers can keep surprising us all.