Europe’s Self Inflicted Oil Crisis And The Saudis Last Laugh With U.S.

Oil producers are in the pole position. Europe increasingly looks like a 120-pound weakling that can’t keep the lights on. And the U.S., producing a steady stream of oil and gas these days and getting some inflation relief at the gas station, may have sold Raytheon missiles for oil.

Europe is currently known for two things at the moment: farmer protests and shooting itself in the foot to create its home-grown energy crisis. Saudi Arabia and Russia are laughing all the way to the bank, as it were.

For example, on Tuesday, Saudi Aramco reported net income nearly doubling, up 90% in the second quarter versus the same period a year ago. All of this is thanks to the European Union banning Russian oil and gas, creating a fiasco for oil and gas traders and insurers who are not interested in getting fined for breaching sanctions. Climate-obsessed states like Germany were even considering using coal to keep the lights on. Such was the case in June. Germany is definitely using coal instead of gas, according to DW.

According to TradingPlatforms.com, Saudi Aramco raked in $48.4 billion in the quarter, up 90% from last year thanks to higher oil prices. "Saudi Aramco is just the latest in a long line of oil giants to announce bumper profits this year. ExxonMobil's XOM profit, for example, came to $17.6 billion in the second quarter,” says Tradingplatforms analyst Edith Reads.

Meanwhile, Gazprom said on Tuesday that European gas prices could go up by 60% to over $4,000 per 1,000 cubic meters by December. The company's exports to Europe, its main market, are down by 36% due to sanctions imposed on Russian state-owned companies as punishment for the war with Ukraine.

Some industry analysts expect natural gas prices to break $10 per million BTUs in the coming weeks as it becomes clear that there will be a shortage this winter. The last time prices rose above $10 was in July 2008. This is a huge headwind for European markets.

Oil prices have fallen, bringing gasoline prices lower. Some see this as temporary, however.

“We’re in a long-term structural bull market in oil,” Schork Group principal Stephen Schork told Yahoo Finance on Tuesday. “By the end of the year, I would suspect that these prices will be back in that $100 to $125 range, which we’ve seen through the first half of this year.”

Saudi’s Get Last Laugh

President Biden can declare a small diplomatic victory following the August 3 decision of OPEC-Plus to raise oil production by 100,000 barrels per day (bpd) starting in September. On the one hand, it validated his July trip to Jeddah because Saudi Arabia seems set to go through with its pledge to increase production.

However, it would appear that Saudi Arabia's leaders got the better of Washington. What they gave in concessions is more than offset by what they have reaped in rewards, and all to the detriment of strategic U.S. interests.

The OPEC-plus recent agreement increased production by a negligible one-tenth of 1 percent of global oil demand — a "rounding error" in the words of one analyst.

Saudi Arabia and the United Arab Emirates, the two OPEC members with the greatest capacity to pump more oil, will boost their output by only 26,000 and 7,000 bpd, respectively, while Russia, whose energy exports are sanctioned, will add 26,0000 bpd on the market.

Sanctions against Russia have hurt its economy, but the oil money is flowing. Russia and the Saudi government have gotten closer. It is known in Washington that the Kingdom gets along better with the Kremlin than it does with the Biden Administration.

At the start of the Ukraine war, Washington was looking under rocks and stones to see if they could find evidence of China backstopping Russia’s financial market sanctions by giving them cushy business deals. A few became known, like guaranteed wheat purchases and a gas pipeline deal that was likely in the works before Russian tanks rolled into Ukraine.

But of note is that the Saudi government was just as willing to lend a hand. They doubled their imports of discounted fuel oil from Moscow, which it uses to generate domestic power, freeing up its crude supplies to sell at higher margins to the Euros up north.

Saudi Aramco got the best of both worlds: they placated Biden with a modest production increase so he could declare a win while buying lower-cost Russian imports to supplement their market. The U.S. makes no noise about it. Meanwhile, the Europeans are bending over backward to advertise their disdain for Russian oil and gas.

It is worth noting that a lot of this is theater as the Europeans are buying Russian natural gas. Volumes might be lower, but they sure are dishing out more money than they did a year ago. This Tweet below is from Robin Brooks, the chief economist at the Institute of International Finance in Washington.

On August 15, Gazprom said it would ship 41.9 million cubic meters of piped gas to Europe through Ukraine.

Okay, You Can Have Your Patriot Missiles

In February 2021, Biden’s first whole month in the White House, the new administration banned offensive weapons sales to Saudi Arabia. Before going to Riyadh in July, the Biden administration said the ban could be lifted if Saudi Arabia stopped fighting with Yemen next door.

On August 3, the State Department said a defense contract deal could go through, according to a Defense Security Cooperation Agency statement. Saudi Arabia will buy 300 Raytheon Patriot missiles for more than $3 billion.

While Washington would never say so, it looks like this oil deal happened because the U.S. lifted its offensive missiles sales ban. At the very least, the truce with Yemen was extended, giving the U.S. a chance to say it was a good deal: we got more oil, Yemen got peace, Saudi got its defense contract, Raytheon makes $3 billion.

As a result of that deal, oil prices are trending downward. Speculators that drove up prices late in the second quarter have cashed in. The market has evened out, for now.

Oil Market Forecasts

Within investor chatter on social media and at the Wall Street water cooler, the concern is that while global oil prices have returned to pre-Ukraine invasion levels, these are not all due to the Biden-Saudi deal.

The global economy is slowing. China is in rough shape. The U.S. economy is in a technical recession.

Softening global demand has kept a lid on oil futures for now. But if Stephen Schork is correct, the temporary price lull will not likely last long.

OPEC expects global demand for oil to exceed the increase in supplies by 1 million barrels a day next year.

The International Energy Agency in Paris expects oil demand to continue rising towards pre-pandemic estimates. Meaning a reasonably straight line upwards, even as the Western powers, led by Europe, try their hand at going to zero carbon emissions by 2030.

According to OPEC, its members would need to provide an average of 30.1 million barrels a day in 2023 to balance supply and demand, which is over a million barrels a day more than member states produced in June.

Given the economic strife caused by sanctions, Russia is in no hurry to overproduce.

Given that Europe has spent the last few years telling the Saudis it doesn’t want its dirty fuel anymore, the Saudis are in no hurry to sell them their oil and would rather cut deals with the Chinese.

The good news here is that the U.S., not an OPEC member, can weather this better than Europe.

Europe’s decision to close down the oil trade with Russia simply led to a shift in trade routes: Saudis shipped more of its oil to the world markets while importing Russian oil for use at home. Thanks to this arrangement, Russia’s economy contracted only 4% in the second quarter when early estimates were for double-digit contraction and a deep recession.

Moreover, Russia has overtaken Saudi Arabia as the largest exporter of oil to China, and India has increased its imports of Russian crude from almost nothing to more than 760,000 barrels per day.

There is little chance that Brussels or Washington can convince Saudi Arabia to move away from Russia. They will continue with the Russian imports while selling their premium oil to a fearful Europe, with a penchant for self-harm. Besides, an open break with Russia would ruin the OPEC-Plus architecture, which is critical to maintaining a modicum of global price stability.

The U.S. would be wise to use its domestic oil and gas supply to replenish reserves instead of selling it to the Europeans, who prefer wind and Chinese-made solar panels.

Lastly, Saudi Arabia and other OPEC members have made clear that any meaningful increase in oil production for the West to offset reduced supply from Russia will require significant upstream investment. There is no reason for them to make it. They are doing fine without it. Their people are not rationing energy or rioting because of high fuel costs.

Citing "unrealistic energy policies," Saudi officials noted that the trade-off between renewables and fossil fuels is a false choice.

Jamie Dimon, CEO of JP Morgan, said something similar over the weekend. "Why can't we get it through our thick skulls that…it is not against climate change for America to boost more oil and gas," he said. (Looks like JPMs ESG score just fell 100 points…)

The transition to solar and wind is a long-term process. Germany is wise to be sticking to nuclear. China is loaded with new nuclear power plants in the works. But in the meantime, only by means of a rapid and intensive development of oil and natural gas can Europe minimize the economic impact of their anti-Russia policy, a policy they got from Washington.

Back in Washington, Biden's visit to Saudi Arabia and August's OPEC Plus won’t save the allies of Europe, and it is unclear if it will keep gasoline prices trending lower there. That might take a full-blown recession, something many in the market are still predicting.

If the United States doesn’t want to be like Europe and is serious about putting an end to the double-dealing of its allies, then it will have to make tougher and more decisive choices about its energy future rather than going all-in on a post-fossil fuels economy. Investors are not stupid. They will look to the economy where energy costs are the cheapest. Corporate and portfolio money will go there.