Stability issues in Middle East to impact OPEC talks

Stability issues in Middle East to impact OPEC talks
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When OPEC leaders convene Thursday in Vienna, the global context affecting their decisions will contrast starkly with that of previous years. Pushed by tightening of the market, oil is trading at its highest price in more than two years and is likely, in the medium term, to climb higher.

In a tight oil market, geopolitical developments in oil-producing states and countries located near major oil transit routes have an amplified impact on the global oil price. Geopolitical risks are now in abundance in oil-producing nations, particularly at the center of global oil production — the Persian/Arabian Gulf.

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Thus, the combination of a tighter oil market and rising geopolitical risk in producer states creates conditions for oil price escalation.

 

What has happened to the global oil market? The most important factor affecting the oil price is the basic fundamentals of supply and demand. Economic data in major oil-consuming states, including China, indicates current and future demand growth for oil.

Physical stores of oil are declining, indicating that demand is outstripping current supply. Thus, the current market fundamentals are conducive to preserving the current oil price and even for it to climb.

When the oil market is relatively tight, geopolitical events significantly influence the global oil price. In contrast, in recent years, due to the very liquid state of the oil market, instability and even major production going offline did not have significant effect on the oil price.

Thus, instability lowered and brought production offline in Libya and Iraq, for instance, with little sustained influence on the global oil price. 

However, under the new fundamentals of the market, major reductions in supply or threats to oil transit routes will affect the price and lead it to rise. The Middle East is currently at one of the most perilous periods in close to 50 years.

The current quagmire includes:

  • Russian active military presence in the region;
  • unpredictable American policy;
  • potential for direct confrontation between a variety of militaries operating in the region — Russia, U.S., Turkey, Israel and Iran;
  • potential for domestic instability in Saudi Arabia itself;
  • rising terrorist attacks in Iran — many ethnic-based — that could lead to volatility there;
  • rising chances of violent conflict between Iran and Saudi Arabia and these rivalries playing out in proxy wars in Yemen and Lebanon; and
  • the risk of potential widening of proxy arenas to Bahrain and elsewhere. 

The Middle East has become a multilevel chessboard on which few policymakers can make the right move or even understand the interlinked developments. The combination of this instability with the new state of the oil market amplifies the impact of instability in the Middle East on the oil price.

In addition, the involvement of Saudi Arabia has a unique impact on oil price trends. Saudi Arabia holds the mother lode of oil, and domestic instability in the Kingdom or direct or proxy fighting with Iran would lead the oil price to soar.

Venezuela, Nigeria and Iraq are additional states where production volumes are at risk. The recent spill and subsequent closing down of the Keystone Pipeline also helped to boost the West Texas Intermediate oil price indicator. 

The OPEC meeting will take place against this geopolitical backdrop. The main decision OPEC ministers will make at the summit is whether to extend their production ceiling beyond their March 2018 agreement and, if so, for how long.

Most likely, they will agree to a compromise extension of six months to maintain stability in the market. In order to maintain its current good political cooperation with Saudi Arabia, Russia will most likely go along with the formal maintenance of the production freeze. 

A new element of oil geopolitics is how Russia has become a major decision-maker in the oil market. A sharp illustration of Russia’s new leadership role in OPEC is the agenda for the Thursday meeting, which will conclude with a press conference of the president of the OPEC conference, OPEC’s secretary-general and the Russian minister of energy.

For most of the past two decades, Moscow and its oil companies had a pretty laissez-faire approach to the oil market, and they were happy to produce and pump as much as possible. Today, Russia’s decisions are critical to OPEC’s decision-making outcomes.

This was unfathomable until recently. This new role complements Russia’s closer political cooperation with Saudi Arabia, which developed in recent years and gives Moscow even greater influence in the Middle East. 

However, the oil price trend will most likely be decided by events outside the meeting room. Iran ratcheting up its confrontation with Saudi Arabia is of critical importance. Instability in Saudi Arabia serves Iranian geopolitical interests, but it also would raise the price of oil, something Iran strives for.

Iran may also clandestinely attack oil pipelines and other oil infrastructure in the region as part of its drive to raise the oil price. Riyadh’s own recent domestic moves against parts of the ruling and commercial elite risk volatility as well.

In addition, Iran itself is not immune to potential insecurity. In the past six months, Iran has witnessed major terrorist attacks in Tehran and multiple attacks on soldiers and military installations in its border areas.

All of these attacks are linked to Iran’s ethnic minorities, which comprise 50 percent of the population. Ethnic-based terrorism in Iran is rising, creating domestic security challenges for Tehran.

In recent years, due to the liquid oil market, the oil price trend had relatively delinked from events in the Middle East. Due to the new state of the market and the focus of new sources of potential instability in Gulf producers, the link has returned.

Brenda Shaffer is a specialist on energy and foreign policy. She is a visiting researcher and professor at Georgetown University’s Center for Eurasian, Russian and East European Studies and a senior fellow at the Atlantic Council’s Global Energy Center. She is the author of  several books, including, "Energy Politics" and "Partners in Need: the Strategic Relationship of Russia and Iran."