Last week OPEC performed conferences with a coalition of companions which have labored collectively to restrict oil manufacturing since 2016. It was broadly reported that the group hoped to come back to an settlement to scale back oil manufacturing by a further 1.5 million barrels per day (BPD).
The conferences got here within the wake of reviews from the IHS Markit Crude Oil Market Service that Q1 2020 world oil demand will decline by three.eight million BPD from a yr earlier. This will signify the most important quarterly demand decline ever reported.
But this time one of many key companions of the coalition, Russia, refused to take part in further cuts. They had beforehand signaled their resistance to further manufacturing cuts in February when OPEC floated the concept.
Oil costs plunged by practically 10% following this shock transfer by Russia. It had been broadly anticipated they’d associate with the plan, as a result of the choice appeared a lot worse. So what precisely are they pondering?
Let’s rewind again to 2014, when OPEC initially declared battle on U.S. shale oil producers. Oil costs had begun to weaken as shale oil manufacturing continued to increase, so OPEC determined it wanted to behave to guard market share. A worth battle ensued that dropped oil costs all the best way into the $20s. At that point I famous that the choice would in all probability price OPEC a trillion or extra (and it seemingly did).
While some shale producers had been compelled out of business, most had been way more resilient than OPEC had imagined. Thus, two years later OPEC waved the white flag and returned to the technique of creating manufacturing cuts with a view to help costs.
The draw back of this technique for them was that, whereas these manufacturing cuts do assist help oil costs, in addition they maintain U.S. shale oil producers in enterprise. So, shale manufacturing within the U.S. stored increasing. This put OPEC within the cycle of getting to chop manufacturing many times as shale manufacturing stored climbing. Many OPEC members deemed this unfair, however that they had already skilled the choice and it was worse.
From Russia’s viewpoint, all this technique was doing was propping up U.S. oil producers on the expense of everybody else. The solely means this technique would finally work could be for OPEC and its companions to maintain reducing till U.S. shale oil manufacturing started to say no. Their hope was that this occurred sooner slightly than later, however within the interim OPEC manufacturing fell to a 17-year low.
It’s price noting that Russia additionally wants the cash from its oil exports. But it’s embarking on a doubtlessly costly gamble in refusing to cooperate with OPEC. They might promote extra oil this manner, however at a far lower cost.
Coronavirus Changes the Equation
But the worldwide coronavirus (COVID-19) outbreak has compelled the problem. Now, as an alternative of getting to take care of the addition of one other million BPD of U.S. shale yearly, abruptly that they had to deal with tens of millions of barrels of extra oil available on the market as demand collapsed in response to the coronavirus outbreak.
So, Russia is successfully revisiting the 2014 technique of defending market share. Saudi Arabia, in response to Russia’s resolution, made the most important cuts to the worth of its crude oil in additional than 30 years. Aramco shares, in flip, fell beneath their IPO worth for the primary time.
I’ve written many occasions that OPEC is in a no-win scenario with respect to U.S. shale oil manufacturing. The group tried one pricey technique, after which one other, and now it’s being compelled by Russia again to the unique technique.
oil costs may fall a lot additional with out Russia’s cooperation in making further cuts. Now that it’s clear that that is the trail ahead, we’re getting into an especially painful interval for oil producers all over the place. Oil costs will collapse. Oil producers are going to go bankrupt. Government budgets are going to be drained in oil-exporting nations.
The End Game
It is probably going, in my opinion, that the endpoint can be much like the final time this technique was tried. Oil costs may dip all the best way into the $20s. Russia will in all probability finally…