Article12 Nov 2020

Subtle Geopolitical Impacts on Oil Prices with a Biden Victory

While market attention has focused on the bearish potential return of the U.S. to the JCPOA with Iran, the U.S. election could have an immediate impact on the outcome of the OPEC+ meeting on December 1, as a Biden Presidency would likely impact and solidify the relationship between Russia and Saudi Arabia. This would be the case even if the Senate remains under Republican control.

Flash back to September 2016 and the bilateral agreement forged between the two giant oil producers at the G-20 meeting. To be sure, there were plenty of regional political and oil market factors at work, given the growing stakes Moscow had in the Middle East, weak oil prices, and the challenges exploding U.S. shale production had on their market shares and on market fundamentals. Also at work was a shared concern of the likelihood then of a Hilary Clinton victory in the U.S. Presidential elections that autumn.

2020’s predicament for both Moscow and Riyadh is even more severe than what they confronted in 2016, in our view, and reinforces the optionality for each government in further cementing their common interests and relationships.

In both capitals, a Biden Presidency opens the door to the possibility of deteriorating relations with Washington. In the case of Moscow, additional punitive financial sanctions look likely over a host of issues including alleged interference in the U.S. elections. In the case of Riyadh, it is clear that what has been a close and supportive U.S. policy could cool, but the question is how significantly a more values-driven U.S. policy could see criticism of the Kingdom’s human rights record and the question marks around Jamal Khashoggi result in more uncertainty around U.S. support for Saudi security.

Oil market and geopolitical conditions are likely to drive Russia and Saudi Arabia into greater cooperation in dealing with oil market supply and into further engagement on regional and common global issues. The immediate issue is what the level of oil prices might be when OPEC+ meets on December 1. A Biden Presidency makes it more likely that the larger members of OPEC+ would take a more conservative approach and, depending on whether oil prices remain in the $30 range, could lead them to cut production further come January.

At higher price levels, they could postpone their planned 1.9-m b/d increase in output, or reduce its dimensions by 50% or more. It looks exceedingly unlikely they would add the full 1.9-m b/d back to markets on January 1. A Biden Presidency, by increasing the value of the optionality embedded in the Saudi-Russian bilateral relationship, could make it more likely they will back their bilateral agenda once again with potential new projects between the two countries, including not only in energy, but also potentially in arms sales/purchases.

An About-face on U.S. Climate-change Policy Portends a Big Shift in U.S.-China Relations

There are deeper and broader significant geopolitical ramifications for the world of a Biden victory when it comes to U.S.-China relations. These could include a newly sparked partnership on climate change and a roll-back of challenges to a more global society, with a return to older rules of the road when it comes to trade, more broadly defined.

There is little doubt that one of the first action items of a Biden Administration would entail a rejoining of the Paris Agreement and with it a rebirth of the U.S.-China alignment that led to the success of that agreement. It is close to inconceivable to envisage a meaningful step toward a significant reduction in carbon and methane emissions without action by the two largest economies and two of the largest emitting countries in the world. While Beijing’s recent actions on targeting peak greenhouse gas (GHG) emissions by 2030 and becoming carbon neutral by 2060 might be based on domestic Chinese issues (including power consolidation by President Xi), there is little doubt that it has thrust China into being at least an equal player with — if not a much more significant one than — the European Union and Japan. With a Biden Presidency and its own stimulus package and policy prescriptions, the U.S. will likely become more than a co-equal on climate change policies and the institutionalization of new global norms.

Many of the people who would enter a Biden Administration share the historical legacy with officials of China of leading the world into the Paris pact. That bodes well for a rapid change in discussions between the two countries that could lead to greater international institutionalization and coordination of actions around the world. Undoubtedly, the actions taken by China, the U.S., EU, Japan and other countries — including the oil and gas producers in the Middle East and Russia — are rooted in domestic political conditions as well as hopes and dreams that go well beyond climate change. China’s policies begin with the domestic concerns about pollution and they involve mobilization of capital to make China more competitive in the world by fostering new technologies at the heart of a new wave of green energy-based economic growth and obviously new jobs. These are similar to and overlapping with the same incentives as the other major players in the geopolitics of climate change. That should not impede joint projects and the establishment of new global norms and institutions let alone the basis of more cosmopolitan relations between the U.S. and China.

However, this does not mean a quick end to tensions between the U.S. and China or between them and other countries. The very fact that the EU, China, and the U.S. under a Biden presidency will all be seeking to promote new technologies to create new jobs through green policies sets them up to compete with one other on the very technology issues that lie at the heart of economic difficulties between China and other countries. These involve technology transfer and cyber security issues that raise questions about how even a playing field exists in trade and investment in high tech areas.

More generally, another change in approach on broader trade issues is likely to be in order with any change in a U.S. Administration. A Biden Administration will almost certainly welcome a return to trade norms that the Trump Administration has by policy intentionally scuppered. The World Trade Organization (WTO) is a significant case in point. Over the past four years, the U.S. government has undertaken actions to weaken international institutions and norms, particularly those involving trade. As recently as last week, the U.S. blocked the selection of a new WTO Director-General (DG), who had strong consensus backing from other countries. The replacement of the WTO’s head has long been simmering and the U.S. had insisted on the U.S. citizen as DG. Last week’s consensus candidate is, ironically, a joint U.S.-Nigerian dual citizen, educated in the U.S., although she has also served as Nigeria’s Finance Minister. The U.S. squabble with the WTO started at the beginning of the administration, with its desire for bilateral trade deals and efforts to reduce the authority of the WTO’s adjudication capacity. It has done so by refusing to allow the replacement of Appellate Body judges.

Any full return of the U.S. to the WTO is likely to facilitate a significant but not complete reduction in U.S.-China trade frictions. It should entail a move back to most-favored nation trade principles that expand bilateral trade agreements to other trading partners and it would likely provide pressure on China for accepting the consequences of its own WTO violations. The U.S. attacks on the WTO over the last 3+ years has taken pressure off China in dealing with accusations about its own violations of trade rules and its commitment to them.

There is no doubt that critical differences between the U.S. and China on trade, intellectual property, democratic and human rights values, cyber security, and on a host of other security issues in the Pacific region and globally will persist for a long time. However, a rapprochement between Beijing and Washington on issues of common interest on climate change, and discrete trade issues, can set a new path in the dialogue between the two countries and their relations with others on major global issues. The security and technology divide between the two countries is bound to persist and there is no doubt that state-sponsored technological innovation in China poses challenges not just for the U.S. but for other countries and economies as well. These challenges require an array of countermeasures, including a revival of government-sponsored R&D in the U.S. and elsewhere as well as pressure and enforcement on China when those efforts reflect subsidies and impediments to investments that run counter to agreements on which China has agreed.

Other than a rapprochement on environmental themes and potentially an easing of trade tensions, which would be more optimal for both countries, the relationship between the two superpowers is likely to remain fraught on several other fronts, and would have continued to be the case regardless of who was in the White House. Without directly referring to the ongoing confrontations between Washington and Beijing, discussions from the latest China Communist Party (CCP) plenum spoke of the role of the Chinese participation during the Korean War to keep foreign powers at bay. It also outlined multiple strategic directions for the country, mainly centering on modernization of the economy, supply chains, energy, and military, as well as enhancing domestic consumption, rural development, land use and security, among others. Through upgrading its industries and economy and improving its security, it goes without saying that China envisions its plan as a way to strengthen both its economy while bolstering itself against possible future escalation of tensions with the U.S. and its allies on several fronts, including economic, political, technological, and potentially beyond. It is not surprising given recent diplomatic missions by U.S. Secretary of State Pompeo to Japan, India, Sri Lanka, the Maldives, Indonesia, and Vietnam, as well as recent arms sales to Taiwan.

Two Oil Market Unknowns: Iran and the U.S.

There is a host of oil market unknowns, particularly on the supply side, that have nothing at all to do with a potential Biden victory. These include both the potential for supply disruptions in Iraq, Nigeria, and other petro states incapable of making ends meet and delivering safety and services to their populations, mirrored by potential production returns in Libya and elsewhere in countries with significant reserves and recent disruptions. Two countries stand out, however, when it comes to places where a Biden victory could have consequences on the supply side — Iran and the U.S. These would be the moderately —if not extremely — bearish potential consequences of a return of 2- to 2.5-million barrels per day (m b/d) of Iranian liquids supply should the U.S. ease or even lift sanctions on Iran. They could be potentially bullish if a Biden Presidency were to implement aggressively a “Green New Deal” that limits and/or raises the regulatory cost of U.S. oil production. However, both of these outcomes are exaggerated.

As for Iran, oil sanctions could ease, yet a 2-m b/d increase by end-2021 looks extremely optimistic. Many analysts have seen the election of Joe Biden as President and a potentially rapid return of the U.S. to the Joint Comprehensive Plan of Action (JCPOA) as super bearish for oil prices. We think this is greatly exaggerated. Negotiations will have to be set up between two willing parties. Iran’s Presidential elections in June 2021 are just one of the many major barriers to a rapid return to the negotiating table. Agreement on a set of issues that have changed their scope and nature is another non-trivial requirement.  As a result, we think Iranian production would be unlikely to rise by more than 500-k b/d in the first year of a Biden Presidency.

As for U.S. production, undoubtedly the COVID-19 pandemic and low oil prices have already cut U.S. production by nearly 2-m b/d from its peak. But the U.S. is still an 18-m b/d liquids producer (including natural gas liquids, biofuels, and other liquid fuels) and no matter what policies might emerge in a Biden presidency, for the time being what counts are two related factors: the price of oil, and the “call on shale,” and there is little on the horizon to change that. We see the U.S. rig count continuing to rise into mid-2021 when we think the oil directional rig count could reach around 415 rigs — the level needed to sustain production and halt a continuing decline in U.S. output. After that, a continued return to production growth is also price dependent. At a hypothetical price of $60/bbl for WTI, Permian Basin producers in the U.S., which include two super majors and a host of well-heeled independents, will likely dramatically increase their rig count. That would enable them to exploit the U.S. reservoir of rapid-response, short cycle oil and total U.S. oil output could rise by 1-m b/d within 6-9 months, and continue at that rate going forward. That nightmare continues to haunt the OPEC+ producers.

There is little doubt that climate change issues will be front and center in a Biden administration but it will be more difficult to accelerate decarbonization and related efforts with Republican control of the U.S. Senate. A return to the Paris Agreement, as we noted earlier, will be almost certainly one of the first acts the Administration would likely undertake. Legislation will generally be far more difficult — with some potentially important exceptions — than might otherwise have been the case. There is a large arena of policy in which the federal government exerts massive influence — control over licenses to exploit minerals on federal lands or in federal waters, control over interstate pipelines, pipelines to and from Canada and Mexico, and over federal ports. Existing laws, including the Clean Air Act, the ability to set efficiency standards for various energy uses, other authorities that can facilitate renewable power projects and curb carbon emissions will all remain in place, even if litigation against their use could slow change and technological innovation. There also is a good chance that a set of factors can bring bipartisan support, especially around infrastructure projects and even potentially within an early stimulus package aimed at job creation. The fact is that the energy sector’s labor force increased at double the rate of employment growth for the country as a whole in the half decade before 2020. An ‘all of the above’ energy package including both ‘old’ and ’new’ energy could probably gain majority Congressional support.

Climate Change
Oil Market

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