After a respite yesterday, in which crude oil prices rose after an historic collapse on Monday, oil is moving south again this morning. As I write this, WTI (West Texas Intermediate, the benchmark used to set futures contracts in New York) is barely at $33 a barrel while Brent (the more often used global standard set in London) is below $36.
Even after yesterday’s gains, WTI has shed 28% in less than the last five sessions; Brent is down 28.2%.
These are massive losses anyway you look at them.
The situation is not going to improve in the short term. That’s because the agreement between Saudi Arabia and Russia that has underpinned the cuts in global production has been destroyed. And with COVID-19 (coronavirus) injecting massive uncertainty into oil demand forecasts, the combination has driven prices sharply down.
The past two days have found me in prolonged telephone conference calls with members of my worldwide network.
COVID-19’s Full Impact Is Hard to Measure – That’s the Problem
Everybody acknowledges that the virus’ apparent impact on economic activity remains anecdotal.
Yet that also means what cannot be measured will tend to have a magnified negative pressure on energy contracts.
The current 2.1 million barrels a day cuts in production have underpinned oil prices but are scheduled to end on March 31 – absent any agreement to extend them. Additionally, OPEC had proposed additional COVID-19-inspired cuts of 1.5 million barrels.
All 3.6 million barrels came crashing down last Friday in Vienna when Russia (the main non-OPEC participant in the so-called OPEC+ arrangement) refused to agree.
OPEC had not helped matters any by presenting the new cuts as a take-it-or-leave-it proposition on the entire 3.6 million. Russia left it.
Talk of Cuts Is Over; Production Hikes Are Inevitable
The mess is accentuated by decisions to increase production in another contest over market position. Saudi national oil powerhouse Aramco announced it would boost daily production from 12 million to 13 million barrels per day, but daily volume was 9.7 million barrels just two weeks ago.
Other OPEC members are certain to follow suit, while Moscow has indicated it will also throw open the taps.
All of this new supply in the absence of any expected rise on the demand side will propel prices downward; all parties know this. However, this is now a matter of national policy and that means the discord will continue.
My contacts in Russian oil point out that the Kremlin believes it can withstand the competition since it has amassed a large revenue surplus in its sovereign wealth funds (SWFs). The main Russian national oil companies are known to have lobbied against production cuts (even an extension of the 2.1 million barrels in force) arguing that the harm to their bottom line was reaching serious proportions.
Yes, price levels impacted by production cuts are a factor. But Russia needs to extend export networks to meet needs. The companies have concluded that could not happen under the present format of OPEC+ operations.
Instead, according to my sources at Minenergo (the Russian Energy Ministry), the exports can only be advanced by securing Russian ascendency in the European market while increasing exports to Asia. These objectives cast Moscow in direct opposition to OPEC export plans.
The Saudis wasted no time in responding.
Less than 24 hours after the failure in Vienna, Aramco announced it was slashing export prices between $7 and $8 a barrel to Europe, the U.S. Gulf Coast, and other markets in a direct drive to under-price Russians (in Europe) and U.S. shale producers at home.
Russia has also taken aim at blunting the volume coming from the US. By driving the price down, American produces have less ability to make adequate margins in exporting crude. U.S. refineries can still lead the world in exporting refined product, but crude oil trade is going to be under pressure.
Nonetheless, even if successful, everybody in my contact circles acknowledges that it will take several months for the pricing attack on U.S. producers to accomplish anything. Well before then we should see signs of production concentration and volume declines as vulnerable companies shutter in well lifting levels.
The Russian-Saudi Price War Is All About Supplying Asia
As I have noted before, the opening of the East Siberia Pacific Ocean (ESPO) pipeline had provided Russia with a direct challenge to Saudi/OPEC hegemony in Asia. That the new ESPO benchmark crude rate provided better quality oil than Saudi Export Light was regarded by Moscow as a further advantage.
This new competitor in the Asian market (where primary advances in worldwide energy demand will take place for the next thirty years) was one of the main reasons why Riyadh pushed OPEC to defend market position rather than price in late November 2014.
That move resulted in a collapse in oil prices though 2015 but also put proceeds from export below what Russia needed to justify a reliance on sales to Asia. This time around, Moscow believes it can withstand the fight long enough to establish footholds for longer-term Asian market activities.
However, the Kremlin will need to be spending increasing amounts from SWF reserves to subsidize its national companies, a process that is certain to be replicated in other producing countries both inside and outside OPEC.
The Saudis retain a dominant position in the global market and have considerable financial ability to enter a prolonged oil war with Russia. Of course, every producer dependent upon national oil companies (i.e., any major provider other than the U.S.) will be running increasing budget deficits as a result of last Friday’s negotiating collapse in Vienna whether there are any other pressures (virus-induced or otherwise) on demand or not.
The Russian and Saudi moves guarantee that even a quick resolution will not impact export contracts until May delivery cycles.
Our consensus is that nothing much will change until an OPEC meeting is called. The present schedule does not have an OPEC/non-OPEC ministerial meeting taking place for three months. Russian sources are now intimating there may be a Russian-Saudi meeting before then.
But in the absence of a substantive foundation for Russian relenting and agreeing to the cuts proposed, now meeting is likely to resolve the latest crisis.
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