Starting in 2014, the year when US shale oil production increased its market share, other producers also continued with oil production, leading to a crash in oil prices, just 2 years later, from $114/barrel in 2014 to $27/barrel in 2016. This drastic fall in oil prices in 2016 forced a meeting between Russia and Saudi Arabia in September 2016, with the meeting concluding at a joint decision between the involved countries to cooperate in managing the price of oil, giving rise to an informal alliance between OPEC member Saudi Arabia and non-OPEC member Russia, the alliance being named OPEC+
This was followed by the famous December 2016 meeting at Vienna, Austria between OPEC and non-OPEC members. It was the first deal since 2001, to curtail oil output jointly and ease a global glut after the two years of plummeting of oil prices which overstretched many budget and caused heavy economical loss in certain countries. The Vienna Agreement was expected to speed up oil market stabilisations, reduce volatility and attract new investments.
Following the agreement, OPEC+ had jointly cut down oil production by 2.1m bpd, Saudi Arabia making the largest reductions in production. Owing to the Covid-19 pandemic, factory output and transportation demand fell, bringing down the overall demand for oil, causing oil prices to fall. On 15 February’20, IEA officially announced that demand growth fell from 11,50,000 bpd to 8,25,000 bpd. Inspite of a fall in global demand, a drop in China’s market called for an emergency OPEC summit in Vienna on 5 March’20. At the summit, OPEC agreed to cut oil production further, by 1.5m bpd. OPEC called on Russia and other OPEC+ members to abide by the OPEC decision. On 6 March’20, Russia rejected the move and also announced that it would no longer abide by the previous cuts, ending the unofficial partnership, with oil prices plummeting further by 10% following the agreement. This led to the the beginning of a price war between Saudi Arabia and Russia.
Digging in further, what was really at the heart of the fallout? Russia’s anger over sanctions targeted at its oil giant, Rosneft Trading. Washington imposed the sanctions last month over its continued support in selling Venezuela’s oil. In fact, Moscow was hoping to get Riyadh on its side to inflict economic pain on US shale producers, who Moscow feels have been getting a free ride on the back of OPEC+ production cuts.
Naeem Aslam, chief market analyst at AvaTrade in a media interview said that the price war won’t continue for a long time since it has been heavily affecting the economies of Saudi Arabia and Russia. Since, Shale oil production has helped US to become the world’s largest oil producer, Russia feels that they can dent US’s business by keeping oil prices below $40/barrel and thus declined to cut oil production any further. Russia instead plans to increase production heavily to achieve its goal of denting US’s oil business.
The rejection of Russia to abide by the 5 March’20 OPEC summit decision has a lot to do with their internal politics too. Igor Sechin, the head of Rosneft has opposing production cuts for a long while and it indicates to the change in the political goal of the Russian regime, from satisfying the needs of the general population to ensuring the sustainability of the Kremlin’s alliance with powerful tycoons, including those controlling oil production who would, in the end, either approve a successor to Putin or a constitutional amendment that would allow him to stay in power for two more terms. And not all of them were happy with Russia's participation in OPEC+. In February 2020, Igor Sechin and Aleksandr Dyukov, the head of Gazprom Neft, again voiced their resistance to further production cuts under OPEC+ as it was going against their production development plans.
Unlike the majority of the OPEC+ countries whose oil production is largely concentrated in the hands of government-controlled national oil companies, Russian oil producers enjoy relative market freedom. The provision of further tax exemptions and financial support to Russian oil producers became economically unjustifiable while all potential loopholes in the Vienna Agreement that allowed the Russian producers to justify their low compliance with OPEC+ obligations had also already been used. At the same time, ahead of the March meeting, the Kremlin's own perception of OPEC+ has changed. It has come to believe that the cartel is losing its ability to shape the global energy market due to the growing oversupply and the beginning of a global energy transition.
Also, by 2021-2023 Russia's oil output will also likely start to fall due to the natural depletion of old oil fields and lack of investment in development and exploration - it is projected that Russia's production will fall from 11.4m bpd to 6.3m bpd by 2036. It will try to do its best to prepare for this by developing new oil production projects, which is hardly possible under any OPEC+ production commitments.
In this context, when Saudi Arabia proposed an additional 1.5 m bpd cut on top of the already existing ones, there was no reason for Russia to accept. It had already decided to pursue its own production strategy and no longer saw a reason to maintain its membership in OPEC+. What is more, Russia was not really convinced that such a cut would help the market stabilise given the drop in oil demand growth from 1.1m bpd to 8,00,000 bpd in 2020 and the expected growth in oil production by non-OPEC+ countries of 2m bpd in 2020.
After Russia declined to accept the 2020 Vienna OPEC summit decisions, Saudi Arabia, led by Saudi Aramco, UAE, led by ADNOC decided to go all in and plans massive increase in oil production, much higher than what Russia aims at increasing.
It seems that one main reason for the ignition of this price war remains to be the disruption of the US shale industry. It has been estimated that $40 pb will only slow the production growth, $30 pb will keep it at the level of December’19 and $20 pb can actually be effective to make the US oil production fall (or maintaining $30-40 pb beyond 2020). US President Trump has given assurance to the shale industry to aid it in order to protect it from the worst effects of the reduction in prices.
Now Russia faced a backlash because things actually didn’t go according to its plan. The collapse of OPEC+ was planned but Kremlin never expected a fully-fledged trade war. Now, Moscow is well aware of the fact that if prices fall below $42 pb, it will run a deficit, negatively affecting the socio-economic scenario of the country, one which Putin well wants to avoid.
So, amid many predictions, would the price war between Russia and Saudi Arabia continue? Russia doesn’t seem to be in any advantageous position and thus might back down and return to the status quo but Saudi Arabia may not, owing to its ability to produce extremely high amounts of bpd, now since the OPEC+ agreements do not stand anymore. Their next moves depend a lot on how much the countries are willing to take economic risks and what their true intention actually is.
ECONOMIC WARFARE
The idea of Washington cooperating with OPEC has long been seen as impossible, not least because of U.S. antitrust laws. U.S. President Donald Trump has repeatedly expressed anger with the cartel because its actions lead to higher prices at the pump.
However, Saudi Arabia’s latest move has put Washington in a difficult position - its battle for market share has led to very low prices but also undermined the U.S. shale industry, which has much higher costs than Saudi or Russia production.
The U.S. administration is facing multiple calls to save the highly leveraged shale industry, which has borrowed trillions of dollars to allow the country to become a large oil and gas exporter despite often uncompetitive costs.
A group of six U.S. senators wrote a letter to Secretary of State Mike Pompeo this week saying Saudi Arabia and Russia “have embarked upon economic warfare against the United States” and were threatening U.S. “energy dominance”.
They called on Saudi Arabia to quit OPEC, reverse its policy of high output, partner with the United States in strategic energy projects or face consequences.
“From tariffs and other trade restrictions to investigations, safeguard actions, sanctions, and much else, the American people are not without recourse,” the senators, including John Hoeven of North Dakota and Lisa Murkowski of Alaska, said in a letter.
Two other senators from oil-producing states introduced a bill on Friday that would remove U.S. armed forces from the kingdom.
Trump last week said he would get involved in the oil price war between Saudi Arabia and Russia at the appropriate time.
The head of the International Energy Agency, an adviser to the United States and other industrialised countries, on 26th March, Thursday, also called on Saudi Arabia to help stabilise the market.
Algeria, which holds the OPEC presidency at present, has called for a meeting of the group’s Economic Commission Board to be held no later than April 10 to discuss current oil market conditions.
Countries have gone into lockdown due to the coronavirus pandemic, with flights all over the world canceled as airlines ground their planes, hitting economic activity and fuel demand. That has led to excess supply flooding the market as well.
With 3 billion people in lockdown, global oil requirements could drop by 20%, International Energy Agency head Fatih Birol said, according to a Reuters report on 27th March, Friday.
"The world is facing a hugely deflationary shock. The WTI oil price has dropped from USD60 in January to around USD20. Demand for many goods has plummeted, as economic activity has gone into stasis," ANZ Research's Kishti Sen said in a Monday(30.03.2020) note.
The deepening pandemic and reduced appetite for crude oil by refiners sent the oil price into a tailspin.
"Amid the worldwide lockdowns, storage capacity is filling fast and may soon run out unless there is an urgent supply cut.”
THE IMPACT ACROSS ECONOMIES
Oil and natural gas continues to play a major role in every economy. The price war between Russia and Saudi Arabia had its effect on almost every country but some turned out to be winners, well some didn’t benefit much.
The countries which import fuel have greatly benefitted from this price war and the producers took the major losses. Peru benefitted being a major importer, Brazil could maintain a stable stance. The US also could rake up some benefits since the price war has put Russia under pressure. Also low gasoline prices could only make the voters happy and help Trump to get re-elected as a president. Venezuela, Columbia and Ecuador suffered heavy losses due to the situation. Things haven’t been great with Canada, Mexico and Argentina either. In Asia, China, India and Japan have benefitted whereas Australia (though an Oceanian country) took a major hit. In Europe, Germany and France did benefit, so did Italy but the the price war seems to be pale compared to the losses these countries are suffering due to lockdown owing to Covid-19. Norway and Russia, both took major hit, as expected. From the middle-east, Saudi Arab, Algeria and Iran, all suffered losses due to the decrease in the price per barrel but they are trying to stabilise it with increased production. Egypt benefitted as the arab world’s ms populous nation is a major importer of oil. Angola and Nigeria, the biggest African oil producers took the major hit whereas South Africa benefitted since it is a major importer, with virtually no oil production within the country.
DID INDIA REALLY BENEFIT? WHY OR WHY NOT?
For India, this may be a boon to pull out the economy from an 11-year low growth rate and rising inflation. The Indian economy will likely see significant benefits from lower crude oil prices -- lower current account deficit, lower inflation, lower fiscal deficit and higher GDP growth (one-time impact of lower imports).
The government's tax revenues saw a spike in FY2016 when crude prices fell sharply. States will, however, lose meaningfully from lower product prices given the ad valorem nature of state VAT on petroleum products; they may also raise VAT on automobile fuels though.
Lower crude prices will benefit automobiles (lower cost of ownership), aviation (lower fuel bill), cement (lower pet-coke prices), consumer companies (lower packaging costs), city gas companies (lower gas prices), oil marketing companies (higher marketing margins on automobile fuels) and paints, Kotak Institutional Equities Research said.
However, upstream oil and gas companies such as Oil India and ONGC may make losses if net realized price is below $35 per barrel, Kotak Institutional Equities Research said.
But, would the citizens benefit from this price crash? No. The government have been importing oil from overseas at the reduced price but continues to sell at old prices, thus having a massive profit margin, which seems to be the reason that the price war considers India as a winner of the situation.
Sources of information -
1) cnbc.com
2) aljazeera.com
3) Kotak Institutional Equities Research
Co-authored by Sushmita Sen and Suman Majumder
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