Middle East oil: rising but not rushing

Nancy Yamaguchi, Contributing Editor, explores how the existence of uncertainty in the global energy market has impacted the Middle East’s downstream oil sector.

What a difference a year can make in the global oil market. In 2021, the world was emerging from the COVID-19 pandemic, and oil prices were surging. Optimism was widespread that a race was underway to return to some sort of post-pandemic normalcy. In July 2021, the OPEC+ group announced that it would relax its self-imposed production ceilings. The new agreement called for additional output of 400 000 bpd each month, beginning in August 2021. This announcement slowed, but did not stop, the upward price trend. The goal was to foster a stronger and more stable price regime that raised producer revenues without stifling global economic recovery. Had it been a simple matter of arithmetic, the ensuing 12 months would have allowed up to 4.8 million bpd of supply back to the market. However, there was no race to return to high levels of production, but rather a a slow hike. Oil supplies grew tighter as COVID-19 began to be brought under control, and demand started to recover.

When Russia invaded Ukraine in February 2022, oil prices surged and have remained strong throughout the summer, despite inflationary pressures and fears of potential recession. International sanctions are cutting into Russian output, keeping the supply side of the equation tight. Yet the OPEC+ group recently met and announced that they would initiate a cut of 100 000 bpd, citing economic uncertainty and the possibility of expanded supply from Iran. It appears increasingly unlikely that Iran will re-enter a nuclear deal, so it is improbable that these supplies will flood the market.

However, the demand side appears weaker than expected, with consumers facing high prices and inflationary pressures. At the time of writing, several new developments are emerging. In the US, the world’s largest consumer country, inflation numbers have been worse than expected, and oil demand in 2022 may actually fall below what was seen in 2021. Around the world, central banks are raising interest rates, so the cost of money is on the rise. In Europe, the Russia-Ukraine war has been long-lived and hard-fought, with a recent rally by Ukrainian forces causing a Russian retreat. Consumers are preparing for a winter of high energy prices. The UK has just lost Queen Elizabeth II, its longest-reigning monarch. Although the monarch does not run the government, Queen Elizabeth was a symbol of stability and wisdom not only in the UK, but around the world. As such, she was highly influential, and her loss brings a sense of uncertainty. Therefore, while the COVID-19 pandemic appears under control and economic activity is recovering, a note of caution is hard baked into the global energy market.

This article examines the oil sector in the Middle East, discussing the impacts of the COVID-19 pandemic, the Russia-Ukraine war, supply and demand developments, OPEC

oil export revenue, and refining. The region could spearhead a new wave of investment in the oil sector and an effort to capture market share, particularly since consumers wish to reduce reliance on Russia. But the question remains: has caution become so firmly entrenched that even US$90 – 100/bbl oil prices cannot tempt a wave of investment?

Oil price volatility: COVID-19 and the Russia-Ukraine war

COVID-19 coming under control in the Middle East

Oil prices are famous for volatility, but the market is in the midst of the most dramatic crash-spike cycle ever witnessed. The pandemic caused immense economic dislocation and oil demand destruction. It even brought one unprecedented day (20 April 2020) when the futures price of US West Texas Intermediate (WTI) crude went into negative territory, closing at -US$37.63/bbl. It took roughly a year before prices crept back up to pre-COVID-19 levels.

The pandemic had calamitous impacts on the Middle East and on countries all over the globe. The rate of new infections and deaths is finally tapering down. Table 1 details the total number of COVID-19 cases and deaths in the Middle East as of 1 September 2022. Over 22.3 million people have been infected, and over 237 000 have lost their lives. Moreover, new variants have emerged, and people remain on guard.

Table 1. Total COVID-19 cases in the Middle East as of 1 September 2022. Source: Johns Hopkins University

Country Total cases Total deaths

Bahrain 671 920 1515

Iran

Iraq Israel

Jordan

Kuwait

Lebanon

Oman

Palestine

Qatar Saudi Arabia

Syria UAE

Yemen

Total

7 530 325 143 894

2 457 871 25 346

4 634 242 11 620

1 735 495 14 110

657 395 2563

1 209 872 10 631

397 846 4628

702 332

429 963 5704

681

813 542

57 058 9297

3163

1 015 879 2341

11 926 2155

22 325 666 237 648 Oil prices remain highly volatile

Figure 1 displays the dramatic volatility in monthly average Brent crude spot prices (US$/bbl) during the 15-year period from July 2007 through to July 2022. Note that these are monthly average spot prices, and that daily price volatility has been even more extreme. In the summer of 2008, monthly average Brent prices spiked to over US$132/bbl. The Great Recession followed, and Brent spot prices dropped below US$40/bbl. By 2011, prices had climbed back up to above US$100/bbl. However, Saudi Arabia then launched an oil price war, which again forced prices down to below US$50/bbl as the Kingdom worked to outlast the competition and regain market share. Prices then fell to approximately US$30/bbl, when sanctions on Iran were lifted, and Iranian crude began to re-enter the market.

To halt the downward slump in prices, OPEC members organised a cooperative effort with key non-OPEC producers, signing a ‘Declaration of Cooperation’. The countries were nicknamed the ‘OPEC+ group’. With the OPEC side led by Saudi Arabia and the non-OPEC group led by Russia, the group agreed to production cuts that helped drain overflowing global inventories and strengthen prices. These measures helped to place prices back in the US$50 – 70/bbl range, but the unforeseen COVID-19 pandemic set all of this back. Mandatory lockdowns and stay-at-home orders caused Brent spot prices to crash to US$18.38/bbl in April 2020.

The sharpness of the price crash was mirrored by the steep take-off of price recovery in 2021 – 2022. Demand returned much more quickly than supply did; the anticipated race to return to high production has been more of a slow walk. For some oil producers, the production ceilings were never binding, and little could be done to expand output in 2021 – 2022. For others, investment in the oil sector had been stifled by weak prices and unpredictable demand

Figure 1. Crude oil price volatility since 2007, Brent crude spot, US$/bbl.

for years, and therefore a significant length of time was/is needed to elevate production. With little new production, oil prices continued to climb in 2021 and early 2022, and then surged to record highs when Russia invaded Ukraine in February 2022.

In March 2022, monthly average spot prices for Brent crude surged to above US$100/bbl for the first time since 2014. Global refinery margins rose despite higher feedstock costs, as refinery capacity has stagnated in many areas and shrunk in others. Gasoline and diesel retail prices hit record highs in multiple markets. During the week of 14 June 2022, the average retail prices for regular gasoline topped the US$5/gal. mark for the first time in history in the US (the world’s largest market for gasoline) – an immense shock to consumers long-accustomed to inexpensive fuel.

Prices have retreated from the June and July highs, and by mid-August, daily Brent spot prices fell to below US$100/bbl. Will the OPEC+ group try to defend a certain price level (US$90/bbl, for example) as a sustainable price? The group recently approved a small cut of 100 000 bpd, intended to promote stability, and Saudi Arabia was given approval to intervene and call special meetings at any time if adjustments become necessary. Although importing countries have been calling for expanded supply from non-Russian sources, the OPEC+ group is adopting a stance of caution, citing weak economics and potential expansion of Iranian supplies if the nuclear deal is revived. The EU and other countries have expressed doubts about Iran’s commitment to the nuclear deal.

The supply-demand balance and Middle Eastern crude production

Middle East and Russian oil exports to Europe

The current oil supply-demand balance is in flux, and far tighter than expected. Post-COVID-19 economic activities have been on an upswing, with oil demand in recovery. However, supplies have been constrained, and the Russia-Ukraine war has heightened geopolitical risk. The West, led by the EU and the non-European G7 countries, quickly launched sanctions to hobble the Russian economy, including actions to shut in Russian exports of oil, revenue from which funds the war effort. Germany, for example, plans to ban imports of Russian crude by the end of the year – an ambitious goal. Europe is the chief market for Russian crude exports. According to BP, Russia exported 263.6 million t of crude oil in 2021, of which 138.7 million t (53%) went to Europe. Europe is also the main market for Russian refined product exports. In 2021, Russia exported 140.7 million t of refined product, 75.9 million t (54%) of which went to Europe. Figure 2 compares Middle Eastern oil exports with Russian oil exports to Europe in 2021, as reported by BP. Russia was the source of 30% (138.7 million t) of Europe’s crude imports, as well as 38% (75.9 million t) of Europe’s refined product imports. In contrast, the Middle East provided 16% (77.1 million t) of Europe’s crude imports and 14% (26.9 million t) of Europe’s refined product imports. Figure 2. Middle East vs Russian crude and product exports to Although Russia is a partner in the Europe, 2021. Source: BP. OPEC+ group, it is likely that there are opportunities for the Middle East to expand its market share of both crude and products in Europe, most likely by diverting flows from Asia to Europe while Russian oil works its way into Asia in the near term. In the longer term, Middle Eastern producers may be able to expand output of both crude and refined product. The most profitable markets, however, may change dramatically once the Russia-Ukraine war ends. Initially, Russia believed that what it called a ‘special military operation’ would be successful quickly, but Ukrainian resistance has been strong. Even when peace is achieved, European consumers may remain wary of returning to such a heavy reliance on Russian oil and oil products, potentially opening the door to Middle Eastern exporters. Figure 3. Monthly change in oil production, OPEC Middle East, ‘000 bpd. Source: OPEC. Middle East attempts recovery in oil production

As oil demand recovered and prices surged, the OPEC+ group announced that it would raise

production gradually by 400 000 bpd beginning in August 2021. The actual growth was far slower. In the Middle East, only Saudi Arabia and the UAE are seen as having enough spare production capacity to significantly impact the market. A concerted investment programme would be needed to elevate production in most countries. Iranian output remains stifled by sanctions, and recent discussions concerning a restoration of the Iran nuclear deal have not borne fruit. The OPEC+ group estimated that Iran could bring an additional 1 million bpd to the global market, but this should not be expected anytime soon.

Figure 3 shows the change in monthly oil production by the Middle East OPEC countries during the period from January 2021 through to July 2022, as reported by OPEC. Middle Eastern OPEC crude production hit a peak of 25.08 million bpd in April 2020, as producers bumped up production in anticipation of the cuts to come. Output then plunged to 17.62 million bpd in June 2020, a drop of 7.46 million bpd in just two months. Output crept back to 20 million bpd by June 2021. OPEC+ announced that it would allow an increase of 400 000 bpd per month beginning in August 2021. As Figure 3 illustrates, however, the monthly increases have been modest. For OPEC in total, production rose by 2.07 million bpd between August 2021 and July 2022.

Global oil supplies have been slow to recover. Figure 4 shows the recent change in oil production in OPEC, Russia, and the Organisation for Economic Co-operation and Development (OECD). In 2020, the COVID-19 pandemic forced OPEC to shut in 3.65 million bpd. Russia cut production by 1.02 million bpd; OECD output declined by 0.91 million bpd.

In 2021, OPEC restored 0.63 million bpd of oil production, while Russia and the OECD brought back 0.21 million bpd and 0.3 million bpd, respectively. In 1Q22, OPEC production rose by 2.01 million bpd, followed by an increase of 0.27 million bpd in 2Q22. OECD production rose by 0.65 million bpd in 1Q22 and 0.37 million bpd in 2Q22. Russian output rose by 0.53 million bpd in 1Q22, but it then fell by 0.69 million bpd in 2Q22, as international sanctions hit. Russia shut in nearly 1 million bpd of production in April 2022. In net terms, therefore, there has been no restoration of Russian oil supply in 2021 through 1H22. OECD countries have expanded output by 1.3 million bpd – more than replacing their loss of 0.91 million bpd in 2020. The EIA forecasts that US production will rise by 0.5 million bpd in 2022, and by 0.9 million bpd in 2023. The OPEC countries raised output by 2.9 million bpd in 2021 and 1H22, but this falls 0.7 million bpd short of the 3.65 million bpd supply drop in 2020.

Figure 4. Slow return of lost supply, ‘000 bpd. Source: OPEC.

Figure 5. Ups and downs of Middle East OPEC oil export revenues, billion US$. Source: US Energy Information Administration (EIA).

OPEC oil export revenues surge

Just as oil prices have gone through severe up-and-down cycles, so too have OPEC’s oil export revenues. Figure 5 shows oil export revenues in the Middle Eastern OPEC countries Iran, Iraq, Kuwait, Saudi Arabia, and the UAE. This declined to US$448 billion in 2019, then plunged to US$251 billion in 2020. Oil export revenues were cut by more than half in just two years – a serious financial shock to countries where oil contributes the lion’s share to government revenue. Iran suffered the largest drop; crude oil export revenues of US$66 billion in 2018 collapsed to US$17 billion in 2020.

The EIA data shows that Middle East OPEC oil export revenues rebounded to US$440 billion in 2021, and revenues are forecast to hit a peak of US$722 billion in 2022. The EIA forecast assumes an average Brent crude spot price of US$98/bbl in 4Q22, followed by a slightly lower average price of US$97/bbl in 2023. The lower price will cause oil export revenues to decline to US$657 billion in 2023.

Middle East refinery utilisation and expansions

Middle Eastern refiners have often contended with low utilisation rates, which fell below 90% in 2009 (the Great Recession) and have never returned to 90% in the years since. Figure 6 tracks the changes in Middle Eastern refinery utilisation between 1980 and 2021, according to data published by BP. In the early 1990s, refinery utilisation rates were often 90% and higher. These rates trended down until 2020, when

the COVID-19 pandemic pushed them down to 75%. 2021 brought rates back to 79%. This was an improvement, yet still below what most refineries consider a profitable level. OPEC reported that in July 2022, US refinery utilisation rates averaged over 93.4%, European utilisation rates averaged 85.7%, and the selected Asian countries of Japan, China, India, Singapore and South Korea had a utilisation rate of over 90.4%.

Refinery expansions have been underway in the Middle East despite low utilisation rates, and many projects remain planned. The recent rise in oil export revenue may make some of these refinery projects possible, though there has been no rush to develop new grassroots refineries when multiple upgrades and expansions remain on the books.

Current refinery projects of note include the 400 000 bpd Jizan refinery in Saudi Arabia, which was completed in late 2021. At first, the refinery was to be built in 2018. The refinery was run at 50% capacity initially, and it plans to ramp up to full capacity in 2022. At full capacity, the refinery is designed to produce up to 75 000 bpd of gasoline, 250 000 of ultra-low-sulfur diesel, and 90 000 of vacuum residue. The vacuum residue will be used as feedstock for the integrated gasification combined cycle plant, which will be the largest of its kind in the world. The Jizan refinery started exporting product in early 2022.

In Kuwait, the 615 000 bpd Al-Zour refinery reportedly began operations in June 2022. The refinery has three 205 000 bpd crude distillation units, and one was being tested. The design plan calls for an output slate of approximately 18 000 naphtha, 53 000 bpd of kerosene, and 62 000 bpd diesel from tower 1, to be doubled when tower 2 is commissioned. The refinery includes atmospheric residuum desulfurisation units to produce low-sulfur fuel oil for use in the power sector. Al-Zour was scheduled to be onstream in 2020, but it was postponed when the pandemic hit.

In Iraq, the 140 000 bpd Karbala grassroots refinery is expected to be completed in September 2022. The refinery will start by refining 70 000 bpd of light and medium crude in 4Q22, and the plan is to ramp up to the full 140 000 bpd in 2023. This refinery is long-awaited. Construction began in February 2014. It faced numerous delays, but it is a sophisticated plant capable of producing EURO standard fuels.

In Oman, the government is working with Kuwait Petroleum International to build a joint venture (JV) refinery known as ‘OQ8’ at Duqm. This will be a 230 000 bpd deep conversion refinery with hydrocracker plus coker. The project is reportedly 92% complete, and start-up is planned for 1Q23.

Conclusion: Middle East oil is rising but not rushing

In the last few years, there has been incredible volatility in the oil market, with tectonic movements across the sector: in demand, supply, storage, trade, price, policy, investment, etc. As the COVID-19 pandemic was brought under control, the year 2021 was seen as a recovery year. It seemed there would be a race to return to normalcy. As economic activity rose, oil

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demand bounced back. But supply lagged and prices soared, and these inflationary pressures jeopardised economic recovery. Middle Eastern oil producers worked to increase production, but the gains were slow.

Geopolitical risks rose in 2022 when Russia invaded Ukraine, and oil prices spiked to multi-year highs. While Russia planned for a short ‘special military operation’, the conflict has been protracted and hard fought. In its usual cycle, market uncertainty has contributed to high prices, which has dampened demand and calmed further upward price

movement. However, it has also discouraged confident investment in the energy sector. The OPEC+ group appears to be concerned that the newest oil price surge could be followed by another cycle of weakness, and has agreed to reduce supply slightly to support prices. OPEC oil export revenues soared in 2021, and they are forecast to climb sharply in 2022 before tapering off gently in 2023. How much revenue is enough to replenish government coffers and invest in upstream and downstream oil projects in the Middle East? OPEC cut 3.7 million bpd of oil production in 2020, and it brought back 2.9 million bpd in 2021 and 1H22. If the Figure 6. Middle East refinery utilisation rates 1980 – 2021, %. Source: BP. Russia-Ukraine war is not resolved, Russian production may be constrained and prices may remain high, potentially motivating other producers. In the Middle East, refinery throughput is rising, and four long-awaited refinery projects are either complete or nearly complete. The years of volatility appear to have instilled caution in the oil market. Anything that swings madly up can come crashing madly down. Even with prices and revenues at multi-year highs, a reversal is always possible. Middle Eastern countries are cautiously increasing crude production, and they have completed some downstream upgrading and expansions. Other plans may be revived or accelerated. The industry is returning, but without a rush.

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