Roule served for 34-years in the Central Intelligence Agency, managing numerous programs relating to Iran and the Middle East. He served as the National Intelligence Manager for Iran (NIM-I) at the Office of the Director of National Intelligence from November 2008 until September 2017. He now works as a consultant on Middle East political, economic, security and energy issues.
The Cipher Brief: The recent oil crisis produced a series of extraordinary developments. Could we sort through this beginning with your take on a broad look at the oil market?
Roule: Sure. I think everyone would agree that the bottom of the demand destruction appears behind us, but the pace of further price recovery will depend on how the global economy recovers, producer discipline, and a few geopolitical events. Economic recovery will occur in phases as different regions experience and move past COVID attacks. It will also take the world some time to work through the glut of oil in storage on land and on dozens of tankers that arrived in US and Chinese ports in recent weeks.
It seems that recovery will be underway by the third quarter of this year and supply cuts in the U.S. and OPEC discipline will likely remain within current bounds. If this hold true, then the coming months should see moderate price volatility, but no deep crashes. Looking further out, we may well see prices edging beyond $40 towards the end of this year with upward price pressure continuing into 2021.
The Cipher Brief: Where does the U.S. oil industry now stand?
Roule: The US oil industry has resized in the most traumatic of circumstances. A good illustration of this new world rests in the number of active US oil and gas rigs. This figure has plummeted since March to around 279, the lowest in 15 years. Companies will be reluctant to increase that number – and banks will be even more reluctant to provide loans to companies seeking to do so – until everyone believes prices have stabilized. Investors will also want a close look at the financial health and field productivity of companies that survive a period in which less-profitable or less-well-capitalized producer, midstream, and field service companies went bankrupt.
All of this will result in a likely reduction in US production by around two million barrels a day (bpd) by the end of the year. At the same time, the U.S. oil industry is here to stay. The oil is sitting in the ground and the technology is improving every year (as well as our ability to use old technology differently). The US also appears committed to a large degree of energy independence.
So, what does this mean for our production? It looks like US oil production in 2020 will drop by around 670,000 bpd and overall oil and condensate production by 2.4 million bpd. Canadian production will also drop by about a million bpd.
The above said, I am a big believer in the resilience and tenacity of this industry. I wouldn’t be surprised if it recovers faster than many predict, especially if oil prices appear stable at the $40-$45 dollar per barrel level.
The Cipher Brief: What is the likelihood that we will see more disruptions, like we just saw with Russia and Saudi Arabia, as the global trend seems to be moving toward more bilateral agreements when it comes to gas and oil sales?
Roule: Unlikely, or at least unlikely on the same scale. First, the oil crisis was a long time in coming, but it wasn’t necessarily unexpected. Even in late 2019, the Russians reluctantly cooperated with OPEC production limits, claiming US frackers benefitted from these limits through a combination of higher prices and an ability to sell to Russian customers in Europe. Moscow was also furious at US efforts to block both Russian oil cooperation with Venezuela as well as the Nord Stream 2 Russian gas pipeline project with Germany. Russia was looking to hurt the US and came to the March OPEC meeting with a determination to do so to an extent that, I believe, surprised the Saudis and others who came to the same meeting with a plan to cut production to sustain prices.
The Saudi subsequent response was also not unexpected. Riyadh’s reliance on Asian customers is critical to its finances and achievement of Vision 2030.
Norman T. Roule, Former National Intelligence Manager for Iran, ODNI
The Saudis – and to a lesser extent the Emiratis – couldn’t allow Russia to grab their Asian market share. At that point, the ceiling on production exploded at the same time that COVID-19 demolished demand. In fairness, no one could have predicted such a scenario. But once the oil war began, it would take weeks to stop and the COVID/oil war ripples would impact economies globally, to include those of Russia and Saudi Arabia.
Although many of these drivers remain, the impact of the global economic crisis, persistence of the COVID virus, and possible policy changes that may come following the November US presidential election suggest that the major oil producers will avoid actions that introduce instability or risk existing market share.
Smaller disruptions are always possible. Events in Libya, Venezuela, West Africa, and Iraq could bring short-term supply problems, but these consumers are new, and their consumers have most likely identified alternative sources.
The Cipher Brief: Has OPEC lost its ability to control the stability of the oil market as we’ve known it for the past 50 years?
Roule: I don’t think so, but OPEC is a different creature than that of the 1970s. We should keep in mind that four of the world’s major oil producers – the US, Canada, Russia, and China – are not OPEC members. Iran and, to a lesser extent, Venezuela have been sidelined through a combination of US sanctions and their own bad behavior.
It may be best to say that whereas OPEC only controls a third of the international oil market, its impact is significant, and it does satisfy a coordination function. At the most recent meeting, the Saudis used the event to successfully press Iraq and Nigeria to meet their production cut quotas.
Norman T. Roule, Former National Intelligence Manager for Iran, ODNI
OPEC agreements now require coordination with and the cooperation of non-OPEC producers to succeed. The intense diplomatic engagement between Riyadh, Washington, and Moscow during the recent oil collapse shows both that OPEC is no longer the sole voice in the oil market and reinforces the fact that the Saudis remains the architect of OPEC policy.
The Cipher Brief: Was it surprising that not all OPEC members agreed to abide by the recent agreement to constrain production?
Roule: No, and this wasn’t unexpected. Iraq and Nigeria achieved only around half of their quota cuts, but I have also seen reports that the actual cuts were far below even these figures. Iraq had difficulty meeting public sector payments, managing budget disbursements to the Kurds, and negotiations to arrange cuts with the various oil companies in Iraq took quite a while. Nigeria has been accused of not meeting OPEC cuts in the past.
At the same time, Saudi Arabia overachieved with an additional, temporary cut of a million barrels beyond its OPEC mandated cut. This brought its production to about 7.5 million bpd, its lowest production since. The United Arab Emirates and Kuwait also overachieved on cuts, albeit at much lower numbers.
The Cipher Brief: How should we be thinking about the recent oil for gold deal between Iran and Venezuela?
Roule: I think this is more of a propaganda victory and not a strategic escape from US sanctions for either party. The amount of gasoline Iran provides won’t satisfy Venezuela’s domestic needs. Iranian technical support to Caracas’ oil sector is insufficient to restore that mismanaged industry. To achieve either of these goals, Venezuela would have to turn to a heavy weight ally such as Russia.
The exchange did allow Tehran to thumb its nose at Washington, however, and obtain a modest amount of gold bullion to bolster its sagging currency and fragile banking sector. Tehran’s earnings on this deal cannot solve its strategic economic problems.
One more point. This event did not signal an expansion in US-Venezuelan ties. The two countries have both been members of OPEC since 1960. The relationship blossomed under former Iranian president Mahmoud Ahmadinejad and Venezuela’s Hugo Chavez. But even here, it was more propaganda than reality. The majority of the many projects Iran and Venezuela initiated never came to anything and the relationship between the two countries faded with the death of Chavez. Iran maintains an interest in Latin America. It is worth recalling that Iran used Mexican territory to launch the unsuccessful 2011 plot to kill the then Saudi Ambassador to the United States.
The Cipher Brief: Are there any other factors on oil prices we should be keeping top of mind right now?
Roule: A few things.
First, we need to keep an eye on the collapse in capital expenditure by US and OPEC companies and whether this is reversed in coming months. In short, companies have dramatically reduced new drilling, exploration, and field production maintenance to cut costs.
US and Canadian firms have reduced their capital exchange expenditures by more than 30%. That’s an amazing reduction and translates to around $50 billion in cuts. Asia and Africa saw similar reductions and even the Middle East – where oil is the lifeblood of economies- expenditures have been cut by something in the neighborhood of 17%. Oil firms are also cutting staff. British Petroleum and Chevron have begun to shed around 15% of their workforces.
Eventually, this will catch up with us as existing field operations need to be replaced. Should firms decide to restore their capital expenditure spending, it may take as long as a year before new projects come online. Even before the recent oil crisis, industry analysts thought existing production might not meet rising demand in coming years as the Chinese and Indian economies continue to expand. This is another reason to look for higher prices in 2021 and beyond.
The Cipher Brief: And what about China? How is it playing into all of this?
Roule: China’s recovery is underway, and its oil demand is approaching pre-COVID consumption rates, but it will take several months to confirm this trend. Domestic consumption appears to be normalizing but the picture here isn’t entirely clear. For example, intra- and inter- city traffic has picked up, but this may be because people are unwilling to use public transportation. China will also need to burn through a record amount of cheap oil it purchased during the oil crisis and while the country was on lock down. The key factors moving forward include whether a second COVID wave shuts down its economy, the recovery of China’s export markets, and what happens between Beijing and Washington. Useful indicators of China’s recovery will include port activity and purchases by its independent refineries.
India’s economic recovery also deserves some comment in that its oil demand collapsed by about a million bpd during the shutdown. At this point, we’re probably looking at a year on year decline of about 8 percent in its imports. Consumption has increased as COVID lockdowns have become more focused, but it is difficult to say when India’s economy will recover from the national and global impact of the virus and economic slowdown.
We should also consider what it would mean if the US returned to the Iran nuclear deal following the upcoming presidential election. If that happened, and sanctions were lifted, this would eventually introduce a tremendous amount of oil into the market. Whatever your views on the current administration’s Iran policy, its capacity to stifle Iran’s oil exports has been an extraordinary display of US economic power. Iran’s exports have dropped from around 2.8 million bpd in 2018 to less than 70,000 bpd in April. Iran’s smuggling makes actual figures hard to get, but by any measure, Iran has ceased to be a meaningful player in the international oil market.
Libya also deserves attention. Due to the civil war, its production has collapsed from around 1.2 million bpd in January of this year to around 100,000 bpd. If Tripoli is able to maintain security and operational control around Libya’s two giant oilfields—Sharara and El Feel, that would put another 300,000 – 400,000 bpd on the market in a few months. Restoration of port facilities and other (costly) infrastructure repairs would allow Libya to return to its 2019 production numbers.
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