DA NANG – The most intense, damaging and far-reaching oil price war in decades has been fueled by the Covid-19 pandemic that is crippling fossil fuel demand worldwide with no end in sight.
Russia and Saudi Arabia, the world’s second and third largest oil producers and the world’s top two oil exporters, failed last week to reach an OPEC+ deal on how best to limit supplies amid virus-stricken demand.
Rather than agreeing to disagree over a plan that would support not only oil markets but the global economy, the two rivals have added to the misery unfolding in global equity markets since markets often take their cue from key index oil prices.
The Brent crude global oil benchmark was trading in the low US$30 per barrel range marking a four year low on Monday and fell another 5% to $28.60 on March 17. Meanwhile, the US oil benchmark Texas West Intermediate (WTI) fell 6.5% on Tuesday to $26.80 per barrel.
Both price points will have major collateral damage for oil producers in the Middle East, Europe, Russia and United States including shale oil producers.
Saudi Arabia took the first shot on March 6 when it announced it would open the flood gates on its massive oil production apparatus.
The kingdom has since increased output from just under 10 million barrels per day (bpd) to 12 million bpd and possibly as high as 13 million bpd to protect and even boost its global market share.
Total world oil production was 80.6 million bpd in 2019, according to the US Energy Information Administration (EIA).
To achieve this the kingdom will utilize its vast spare production capacity, which is the largest in the world. Saudi Arabia also offered discounts to many of its existing customers, adding even more downward pressure on global oil prices.
Russia has followed competitive suit by ramping up its own production, with Energy Minister Alexander Novak saying last week the country had the capacity to ramp production by 500,000 bpd.
Both sides claim they can out last the other in any prolonged oil price battle. The heavyweight battle comes amid a record-breaking oil demand contraction over the impact of the Covid-19 outbreak.
As much as 10 million bpd worth of demand could evaporate in this quarter and beyond, according to Pierre Andurand, head of oil hedge fund Andurand Capital Management LLP.
That, industry analysts say, is creating conditions for a perfect oil market storm of both burgeoning supply and anemic demand.
So who will likely blink first? It’s not immediately clear whether Saudi Arabia or Russia is better placed to sustain a prolonged oil price war.
At first blush it would seem that Riyadh could hold out longer than Moscow since the kingdom has one of the lowest oil production costs in the world, reportedly lower than $10 to produce a single barrel.
At the same time, Saudi Arabia also has the highest global fiscal break even point, the price needed to balance the national books, at around $80 per barrel. The International Monetary Fund (IMF), meanwhile, places that figure in the mid-$80s.
When global oil prices plunged in 2015 and 2016, with Brent dipping below $30 in January 2016, Saudi Arabia was forced to put in place politically unpopular austerity measures and raise funds from international dollar denominated bond issues to keep the country financially afloat.
Russia, for its part, has a much higher cost of production, ranging anywhere between the mid-$20s to low $40s per barrel depending on different analytical assessments.
One advantage for Russia, however, is the nation’s flexible fiscal tax scheme. Last year, when oil prices averaged in the mid-$60s, government levies formed the bulk of expenses for Russian producers.
Russian producers paid between $34-$42 per barrel to the state in extraction taxes and export duties, Bloomberg calculations showed. However, when oil prices fall, taxes drop with them under Russia’s tax system.
Russia also reportedly has a much lower fiscal breakeven price point of around $50 per barrel, though some in Russia claim an even lower rate in the low-$40s range.
Pavel Molchanov, an oil markets analyst with Raymond James & Associates, a multinational financial services company, told CNBC last week that at $30 per barrel the Saudi economy will collapse if the oil price war lasts for long.
Adding to the kingdom’s dilemma, the analyst said, is that Saudi Aramco is now a publicly traded company, meaning it must now answer to aggrieved shareholders.
“Those investors, mostly Saudi nationals who bought on the Saudi Aramco IPO last December, are sitting on losses. This puts immense pressure on [Saudi Crown Prince] Mohammed bin Salman,” he said.
Bin Salman, known broadly as MBS, is credited with initiating the oil price war with Russia by pledging to open the oil production spigots.
Saudi Aramco Chief Executive Amin Nasser boasted on March 16 that Saudi Aramco will continue to pump oil to increase global supply levels, adding that his company was “very comfortable” with $30 oil.
Russia, however, won’t last long either at such low prices, Molchanov said.
He pointed to one scenario where Russia could possibly blink first after April 20, when Russia will hold a referendum on proposed legal changes that would allow Russian President Vladimir Putin to extend his rule beyond current legally mandated term limits.
“Once he gets past that, he’ll be in a position to show flexibility, including in foreign policy,” said Molchanov. “Until then, no way. There’s too much nationalistic fever he is going to still stoke.”
Russian media reports are mixed on Moscow’s ability to withstand a price war. Some have unconvincingly claimed that Russia can withstand the low price environment for six to ten years.
A Moscow Times report on March 16, however, argued that a sustained price war with Saudi Arabia won’t end well for Russia, with no chance national gross domestic product (GDP) will grow in 2020 if the standoff endures.
Meanwhile, the price war is wreaking havoc on the US shale oil industry. Most shale oil producers have a production breakeven point in the mid $30s to mid $40s per barrel, depending on the region and type of shale they use.
Many independent and smaller to mid-sized shale producers were already having balance sheet problems before the war and were being called on by frustrated investors to cut costs, offer or secure dividends and stabilize their finances.
Many shale producers set their 2020 budgets based on oil prices between $55 to $65 per barrel and thus are now scrambling to idle rigs, cut staff and generate cash for expenses just to stay alive in a low price environment that likely won’t lift any time soon.