Any one of many scenarios for the supply and price of oil could come to pass with Donald Trump in the White House, but in the short term, supply and demand rules.

THE outcome of the US election caught everyone off guard. Donald Trump - an entrepreneur and entertainment star with dubious business records and no experience in office - the unlikeliest choice by any keen observer of American politics, will become the 45th president of the most powerful nation in the globe. He succeeds Barack Obama on Jan 20, and, by then, world leaders will need to have worked out a strategy on how to make international deals with a nation headed by a chief executive with an unpredictable, volatile personality.

A bullish case for oil

Oil prices are regulated by a global balance between supply and demand. The drop in the price of the oil barrel from pre-2014 levels had oversupply as its main cause, fuelled by a large number of oil-exploration projects undertaken on the idea that high oil prices would be indefinitely sustainable.

New technologies allowed increasing rates of oil recovery, and fields that previously were deemed uneconomic could finally become profitable.

The shale revolution in the United States has been a key industry development. A combination of horizontal drilling, hydraulic fracturing and high oil prices created the right conditions for a boom in oil production a decade ago. Since then, the market has been swamped with new players. The oil industry became more attractive, and there was a steady growth in oil production in the US and an increasing independency from oil imports.

At the same time, China started shifting towards an economy focused more on services than on major infrastructure projects. News about vacant Chinese shopping malls and entire ghost towns with brand-new buildings and no inhabitants started popping up in the international media. The picture painted was that of the Chinese overshooting in infrastructural projects, to the point that investing in the sector was no longer so attractive.

By January 2016, oil prices reached their lowest levels since 2003. Then came the final blow: Iran's sanctions were lifted and the country could sell oil in the international market. Within four months, Iran flooded the markets with an additional half a million barrels a day and drowned any hope that the price of the dark gold would recover any time soon.

The Trump Effect

During his campaign, Donald Trump had repeatedly criticised the Iranian nuclear deal. In simple terms, the agreement stipulated that Iran would stop pursuing a nuclear programme with military objectives, in exchange for tens of billions of dollars in oil revenue and frozen assets.

This "disastrous deal", in Mr Trump's words, "rewards the world's leading state sponsor of terror with US$150 billion and we received absolutely nothing in return". He said correcting this would be his "No. 1 priority".

That said, he has listed several matters as "No. 1" during his campaign. Since then, he has changed his mind on subjects considered "core" to his voters: his immigration policy of deporting 11 million illegal immigrants has now been reduced to a maximum of three million - and affecting only those with criminal records; and there is his shutdown on all Muslim immigration, which was moderated later in the campaign to the vague strategy of "extreme vetting", to name but two examples.

Mr Trump may or may not try to dismantle the Iran nuclear deal. He certainly will have strong support at home as most Republicans are against the accord - now they occupy not only the White House, but also have the majority in the Senate and in the House of Representatives.

Furthermore, the deal was not a USA-Iran bilateral agreement. It involved the UK, Russia, France and China as well. An American withdrawal will thus not necessarily ruin the whole arrangement; however, it could start to make demands such as insisting on tougher, more frequent inspections in Iran, which could, eventually, force Iran to pull out of the deal.

The Iran nuclear deal was orchestrated by moderate Iranian president Rouhani. He won the last elections with a little over half the votes; the remaining votes were split among a handful of other parties.

New presidential elections in Iran will take place in May 2017 and may pose some challenge to Mr Rouhani's legacy. If the conservative factions are able to unite around a popular candidate who can exploit widespread economic discontent in the country, there is some chance he will not be elected for a second term.

Looking at the growing populist and nationalist movements taking ground around the world, it is not difficult to envisage that this trend could reach Iran. A more conservative president may view complying with the Iran deal as an affront to national interests and call it off.

In this scenario of a broken nuclear deal and the resurgence of international sanctions in Iran, investments in oil exploration in that country could come to an end, curbing its oil output and drying the oil glut the world has been living in since 2014. With less oil in the market, the price of a barrel of oil would climb again, benefiting all other oil exporters.

Another path to a similar scenario: The Organization of the Petroleum Exporting Countries (Opec) finally agrees on an oil-production ceiling. The group of oil exporting countries has unsuccessfully tried to reach an agreement on conjointly cutting production since early 2015. Russia, although not an Opec member, would also be required to stop increasing production if the agreement is to have any real effect on the international oil markets.

However, countries are now locked in a prisoners' dilemma, each looking for their own best interest - which is to produce more oil while expecting that others will cut production. Hence, trusting that all parties will comply and cut their production is an ongoing discussion. The next chapter of this story will be released on Nov 30, when Opec next meets.

However, after so many failed negotiations, analysts are not expecting any meaningful outcomes.

Most likely: Low oil prices in 2017

With the Republicans ruling the Senate and House, it is very likely that Mr Trump will be able to appoint a conservative Supreme Court Justice to occupy the vacant seat previously held by Antonin Scalia.

This position of control will make it possible to have a majority ruling against the Clean Power Plan, which is being fought in federal courts and is expected to make its way to the Supreme Court next year.

A reversal of this plan means less incentive for clean energy and more lax regulations towards coal, oil and gas production in the US. However, with the environmental protection regulations lifted, coal will become cheaper to produce than its counterparts, so what appears at first to be a stimulus to the oil and gas industry is likely to do the reverse.

Another view that can be taken on the pro-drilling and less environmentally-friendly policies a Trump administration might pursue is that oil companies will soon be able to explore areas in the USA considered protected or off-limits during the Obama presidency; it could be open season for oil prospectors in some offshore fields, federal lands and possibly areas in the Arctic.

Mr Trump can also make it easier to get authorisation for pipeline construction.

Any of these scenarios will make room for more oil supply, which will ensure that oil prices will stay low.

In the longer run, Mr Trump's plan to begin infrastructural projects in America will certainly increase the demand for oil. Having pro-oil policies in the US will open the door for a production increase.

However, in the short term, the international oil markets are still controlled by the most basic of the rules: supply and demand. As long as supply is plentiful, oil prices will remain low. This is inescapable.

This article was first published in the Business Times of Singapore on 23 November 2016.

Published:25 November 2016

 

 

 

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