Is a buck a gallon of gasoline in motorists’ future? Will the world witness oil prices at their lowest levels in about 20 years? Will hand sanitizer be more expensive than a barrel of crude? All these questions could be followed with a “yes” if the dispute between Saudi Arabia, Russia, and the oil cartel intensifies in the coming weeks. With Covid-19 tanking global financial markets, crashing crude prices could be the next issue to wipe out hundreds of billions of dollars worldwide.
Don’t Be Crude!
The U.S.-led shale oil revolution has led to global markets being flooded with crude supplies, forcing major foreign producers to reduce their output to ensure prices remained at a profitable level. Since the coronavirus outbreak extended beyond the borders of China, the world economy has been gradually slowing down and oil demand has subsequently diminished.
According to the International Energy Agency (IEA), global crude demand is poised for its first annual decline since 2009 because of the spread of Covid-19. It estimates that demand for this year will slide about 90,000 barrels per day (bpd), down from its initial growth projection of 825,000 bpd earlier this year. The report cited falling crude consumption in China and disruptions to global travel and trade.
The Organization for Petroleum-Exporting Countries (OPEC) recently held a meeting in Vienna to discuss output reductions of 1.5 million bpd for the rest of 2020. The purpose was to insert a floor underneath oil prices. Russia, a member of OPEC+, rejected the proposal and walked away from the table.
Soon after talks broke down, Saudi Arabia announced deep discounts to its official April selling prices and a surge in domestic production. The kingdom is expected to boost output to 10 million bpd, though it has the capacity to reach as high as 12.5 million bpd. Moscow immediately responded by informing the world that it could boost production by 500,000 bpd to a record 11.8 million bpd.
The spat triggered the largest single-day percentage plunge for oil prices since January 1991. During Black Monday, crude plummeted 25% to $33, and some analysts are warning it could slump to as low as $16. Oil did rebound 10% the next day on hopes that U.S. producers would curtail operations and the Kingdom would reconsider due to Saudi Aramco’s public status. But the rebound is likely short-lived – the March 11 trading session witnessed a 4% drop.
Russia confirmed that it maintains sufficient international reserves and can weather temporary market instability. Saudi Arabia reiterated its plans to raise production, scoffing at Moscow’s recommendation to renew negotiations. Mexico, meanwhile, offered to mediate talks between the two sides since the dispute has impacted Latin America’s second-largest economy.
Other OPEC members are now planning to boost output and shipments to avoid losing market share. Iraq stated it plans to increase exports by as much as 350,000 bpd next month, and Nigeria will produce 100,000 more barrels each day.
Looking into Texas Tea Leaves
Barclays says investors can anticipate West Texas Intermediate and Brent prices to crash to as low as $16. Others prognosticate that they could drop to $20. Either way, if the forecasts are even 50% accurate, that would be a huge plunge from where prices were about a decade ago: $140.
Will energy kings ever allow prices to fall that low? There are several factors at play here.
The first is that Saudi Arabia’s Saudi Aramco is now a publicly-traded company. It would be difficult for the kingdom to let crude prices crash to a few dollars, while still floating Aramco shares on the stock exchange. If it were a quasi-private firm, then Riyadh would possess better leverage than it does now.
The second is that the Russian economy is vulnerable. Since Moscow is slapped with sanctions from the U.S. and other nations, and the country trying to recover from the last economic collapse, it cannot afford to have oil prices at these levels for too long. This is especially true when you think about its other key energy commodity: natural gas. Six years ago, natural gas was trading at around $8. In 2020, it has cratered to as low as $1.70. Put simply, Moscow cannot survive both crude and natural gas at these levels.
The third variable is the profit. It is estimated that most foreign producers need prices to range between $50 to $60 to stay profitable. The U.S. needs somewhere between $30 and $40 to remain in the black because of companies’ fracking mechanisms. If prices trade below $50 for too long, then a lot of these countries would be unable to handle it.
Who will emerge the winner of a long, drawn-out conflict? President Donald Trump believes that the American consumer would be the ultimate victor in a crude battle between the planet’s energy superpowers. While the spat would negatively affect U.S. companies, the White House is reportedly thinking about lending financial assistance to the shale industry. Equities are not reacting favorably to the news, despite lower energy costs being a boon for many people and businesses. After a year of tit-for-tat retaliatory trade strife, the world may get to endure a comparable struggle on the other side of the globe. Perhaps investors need to pay for the sins and excesses of the 11-year bull run.
Read more from Andrew Moran.