OPEC’s moves to retain market share mask a subtle power shift in global oil

After several years of bumper oil prices, including what at one point seemed a new normal of $100 per barrel, crude oil-producing nations now have to accept that energy markets are once more interesting. However, while significant attention has been focused on the price war between OPEC and US shale, the current slump in prices is also revealing the shifting sands of power in the global oil market, and the increasingly fundamental role of China within it.

Rising Influence

The current drop in prices began with a slowdown in Chinese industrial demand in late 2014, according to UK-based daily The

Yet while prices look set to remain weak for at least another 12 months, beyond the day-to-day effects of cheap oil lies an arguably even bigger story for the future of the industry: the rise of Asia as the world’s leading oil-consuming region and the growing market role of China in particular. It is a phenomenon that is having an impact across the Gulf, and is prompting oil-producing nations such as the UAE to be more proactive in their response.

Opening Doors

One of the clearest signs of China’s emerging role has been its recent dominant activity in the open market. In October 2014, immediately prior to OPEC’s production decision, a unit of China’s state-run China National Petroleum Corporation (CNPC) secured 36 cargoes of crude oil – equivalent to 18m barrels – primarily from Oman and the UAE. The spree marked China’s largest-ever purchase of crude in a single month and analysts interpreted the move as a sign that the Chinese government was taking advantage of low oil prices to boost its strategic petroleum reserve. The reserve, which is currently in the second phase of construction, is intended to house 100 days of imports by 2020, according to the CNPC. Based on recent monthly imports, financial news service Bloomberg calculated that this would be equivalent to around 570m barrels. Bloomberg estimated in September 2014 that commercial stockpiles in China had reached 261m barrels.

The open market dominance continued into the following year. In June 2015 China again bulk-purchased almost all Oman and Abu Dhabi Upper Zakum cargoes for July delivery, while by late August 2015 China Oil was leasing part of a 2.1m-barrel Omani “very large crude carrier” to store crude within the region, ostensibly to offset price volatility on the Dubai Mercantile Exchange (DME) contract. A collapse in discipline among OPEC members also enabled China, among others, to profit from unusual levels of price competition within the Gulf. By October 2015 Kuwait’s Export Blend for Asia was trading at an official discount of $0.65 cents on Saudi Arabia’s equivalent Arab Medium blend, while the discounts for both Iraq’s Basrah Heavy against Saudi Arabia’s Arab Heavy, and Qatar’s Land Crude against Abu Dhabi’s Murban, were both at record levels. Rather than simply securing its own supplies for strategic purposes, it is increasingly clear that China is looking to profit from its role as a swing consumer – the demand-side equivalent within the industry to Saudi Arabia. Not only does having a large strategic stockpile allow for profitable open market hedging operations during oversupply and contango conditions, which is when the futures price of a commodity is higher than the expected spot price, it also seems China is keen to play a role in market-making as well. In a little heralded announcement in October 2014, Abu Dhabi-based daily The National reported that the Shanghai International Energy Exchange had announced it would be collaborating with the DME to produce a new Asian crude futures contract, which was anticipated to launch in late 2015.

Christopher Fix, former CEO of the DME and new head of CME Group’s Asia-Pacific operations, highlighted the potential challenge of such a new benchmark for Gulf producers in April 2015, when he told The National that in the absence of sufficient liquidity in local trading “the Middle East will get stuck between North Sea Brent and the Chinese”.

Making Adjustments

In response to this potential threat to market-setting power, Platts, the commodities price reporting agency, announced in October 2015 that it would be looking to expand the formula for its current Middle Eastern-Asian benchmark to include two new grades to the three it already uses. The firm’s Dubai benchmark, which sets the price for almost 30m bpd of exports to Asia, currently includes Dubai, Oman and Abu Dhabi’s Upper Zakum crudes, which account for a combined 1.2m bpd. Platts was reported to be seeking industry advice as to whether to add Qatar’s Al Shaheen and Abu Dhabi’s Murban grades to the mix, which would increase the benchmark’s volume by 600,000 bpd.

New Players

As well as taking on an increasing role in the open market, Asian nations are also beginning to engage more actively in the Gulf’s production side. The retendering of the Abu Dhabi Company for Onshore Petroleum Operations (ADCO) concessions remains an ongoing process, with over half of the 40% of shares allocated to foreign oil companies yet to be awarded. What is of interest though are the three concessions that have already been announced. While French major Total was the first new, or renewed, shareholder to be announced, with a 10% holding, the other two companies were awarded smaller stakes, namely, Japan’s Inpex (5%) and South Korea’s GS Energy (3%). With more than 90% of Abu Dhabi crude exports now being absorbed by Asian refineries, the shift to begin to include Asian oil companies as local partners makes sound strategic sense. GS Energy has operated in Abu Dhabi since 2012, where it has developed three blocks at the Haliba field in partnership with the Korea National Oil Corporation, while Inpex’s subsidiary, the Japan Oil Development Company, already has a 12% stake in the Abu Dhabi Marine Operating Company.

Shifting Focus

What is as yet unknown though is whether or not any of the remaining shares for ADCO will be awarded to a Chinese oil company. Expectations were raised in May 2015 when a $330m engineering, procurement and construction contract to develop the Mender oilfield was awarded to the China Petroleum Engineering and Construction Corporation, an affiliate of CNPC. Meanwhile, India is also a major consumer of the UAE’s oil exports, and according to UK-based energy consultancy Energy Aspects, a number of Indian firms, including the Oil and Natural Gas Corporation, are also becoming more active in the country. While the shift east reflects the new realities of the Middle East’s oil market, it is likely that the authorities in Abu Dhabi will take a measured approach to new long-term partnerships.

As The National noted in October 2015, the tumultuous events of the past year are likely to be giving the Abu Dhabi National Oil Company pause for thought. In his column, the paper’s energy correspondent Anthony McAuley said that not only has China demonstrated its determination to maintain flexibility through deals with Russia and other markets that have eaten into GCC market share, but equally, following the expiration of the previously awarded ADCO concessions, a lack of flexibility within the national oil company’s marketing system meant that they have had to rely on big oil corporations for help when market conditions deteriorate.

Looking forward then, the emergence of Asia presents both challenges and opportunities for the Gulf, and for Abu Dhabi in particular, and the coming years are likely to see a new balance struck within the oil sector, as the reality of consumption patterns becomes embedded in new strategic partnerships.

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The Report: Abu Dhabi 2016

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