GP Insights # 293, 14 March 2020
Brent crude oil prices dropped to significantly low levels, comparable to the price level during the Gulf War of 1991. Both Saudi Arabia and Russia have upped the ante, and increased production, pushing the prices to a new low.
Saudi Arabia announced its plan to increase the oil supply by 25 per cent in April, amounting to approximately 12.3 million barrels per day. Russia too responded by announcing that it can pump an additional 500,000 barrels per day. This caused the Brent Crude to plunge by 24 per cent on 9 March 2020. Additionally, the prices of the US West Texas Intermediate (WTI) also dropped to a large extent.
What is the background?
On 6 March 2020, the OPEC meeting in Vienna proposed to cut the production of the crude oil by 1.5 million barrels per day, given the low demand due to COVID-19 in manufacturing economies. A production cut would not allow the prices to slump further. However, the proposal required Russian assent to come into force. The talks between OPEC countries and Russia failed in this regard, and both countries resorted to a pricing war. Other players like Iraq and Nigeria also have announced an increase in their production and supply.
What does it mean?
The "oil war" has shaken the hydrocarbon market and has raised the fears of another economic crisis that the market is unprepared to face. It is essential to understand what it means to different stakeholders. First, the "oil alliance" between Saudi Arabia and Russia is under stress. It further strains the relationship between OPEC and non-OPEC countries, ultimately hurting the market.
Second, Saudi Arabia is at an offensive position, as it seems to be tapping its strategic inventories to increase the supply of crude. Its announcement of 25 percent hike in production, is above the sustainability and capacity of its state-owned company Aramco. Third, the price war might be targeted at the US shale oil that has consistently reduced the market share of the OPEC+ countries. A drop in price would induce the buyers to go to the OPEC+ rather than the US. Texas, one of the largest oil producers in the country, is staring at losses due to the situation.
Fourth, the world economy is in a critical and peculiar state, where demand, as well as production, has reduced because of COVID-19 and so is the case with the crude prices because of the so-called "oil war". If there are no negotiations in the near future with economies of scale in operation, the oil market will continue to plunge.
Fifth, cheaper crude oil would mean a threat to the climate. If manufacturing market returns back to normalcy and the price of oil continues to be cheap, carbon output would certainly be higher.
The "oil war" that has affected the supply side is combined with the outbreak of the epidemic, which is affecting the demand side. The price war might be a failure of negotiations, but all stakeholders are at a gruelling loss.