“We haven’t seen anything like this.” That’s the current consensus from global energy traders and analysts, as oil prices have plunged to multi-year lows amid the price war between Saudi Arabia and Russia and the coronavirus crisis.
The world’s top oil exporter, Saudi Arabia, initiated a price war with Russia on March 8th, following the collapse of an alliance between the OPEC cartel, led by the Saudis, and Russia. The implosion of the so-called OPEC+ alliance was triggered by Moscow’s refusal to follow OPEC’s plan to slash oil supply by 1.5 million barrels per day in an attempt to prop up prices amid weakening global demand.
“Moscow had become tired of cutting production to stabilise prices and felt that the policy of supply restraint gave more room for U.S. shale companies to grow… America has become the number one oil producer in the world and is expected to pump about 13 million barrels a day in the first quarter of this year,” according to CNN.
After Russia’s refusal to go along with OPEC’s proposal, its energy minister Alexander Novak signalled fierce market competition to come when he said the country’s oil production will not be restricted by “the quotas or reductions which were in place earlier” from April 1st. Angered by Russia’s move, Saudi Arabia began its fight for greater market share by offering deep discounts to its preferred customers. The kingdom slashed its oil prices by up to US$7 per barrel and also indicated that it would increase production to over 10 million barrels per day.
Oil demand is expected to contract in 2020 for the first time since the Global Recession
These actions have resulted in a sharp fall in global oil prices. At the beginning of the year, the US oil benchmark, known as West Texas Intermediate (WTI), was hovering above US$60 per barrel. However, it fell below US$20 per barrel on Monday, close to its lowest level in 18 years. As the coronavirus outbreak has become a global pandemic, factories have been idled and people rarely travel. This has severely undermined energy demand worldwide, especially in China, which is the largest crude oil importer spending about 10 million barrels per day. According to the International Energy Agency (IEA), global oil demand is expected to contract in 2020 for the first time since the global recession in 2009. Such weak demand at a time of excessive supply is likely to keep oil prices even lower.
Although Saudi Arabia’s actions are aimed at increasing its market share and punishing Russia, no one is really likely to win the price war. All major oil exporters, including Saudi Arabia, will suffer as a price around US$20 per barrel is not high enough for any of their governments to finance their spending while balancing their budgets. Especially for the Gulf countries such as Saudi Arabia and the UAE, their governments need a price around US$70 per barrel or higher to run a balanced budget due to their high spending and subsidies for citizens. Oil dependent economies that have endured years of political and economic conflicts—such as Iran, Libya, and Venezuela—will suffer even more. The US will also be the victim of the price war as low prices will hurt its producers in states like Texas and Louisiana, which have enjoyed the shale oil boom over the last decade.
On the other hand, low oil prices could provide major importing nations such as China and India with much needed relief. Consumers will also benefit in general as lower prices mean cheaper gas. However, such benefits are likely to be outweighed by the larger economic consequences of the coronavirus. For example, airlines, one of the largest beneficiaries from low fuel prices, have grounded flights due to travel restrictions and drastically declining demand – which means fuel savings offer very little in the way of a silver lining for most airlines.
Meanwhile, although most oil and gas companies are suffering massive share price losses, some major energy traders are using low oil prices as an opportunity to make extra profit. According to Reuters, Vitol and other global oil traders have booked at least five Very Large Crude Carriers (VLCCs) to buy oil now, store it, and sell it later when prices recover. However, there aren’t many VLCCs available at the moment either, as Saudi Arabia has already booked most of them in order to bring all its extra oil to market. The supply-demand gap in the market has become so big that the world has run out of crude storage facilities. Many assume the post-crisis boom in industries will lift prices and excess supply will vanish. Others believe that the fossil fuel industry has been dealt a fatal blow that will kickstart its long-term decline. Only time will tell what is in store for the black gold, the lifeblood of the global economy.