As the number of COVID-19 cases touches 1.2 million across the world, United States is the hardest hit with 0.3 million (as on 5th April 2020) positive cases, a major recession is on the offing. The scale of the collapse in oil demand from the COVID-19 pandemic is staggering. Global demand for crude oil has shrunk by almost 23% compared to the previous year – an indicative measure of Coronavirus impact on the oil industry and this may further increase to 30%.
The industry has also been shaken by the supply side trust deficiency. Failure of the OPEC+ 6th March meet in Vienna resulted in broken alliance and an all-out price war between OPEC-leader Saudi and Russia, to regain market share and the crude oil price dropped to $20/barrel, the lowest level of last 2 decades. Vienna OPEC+ meeting failure fallout led to Saudi Arabia responding by offering discounts on its oil and with a plan to produce 12 mbpd from April 2020 onwards. UAE followed suit of increasing their production. Russia said they can increase production by 300-500 kbpd.
The price war was irrational, given that the Saudis require at least $70/barrel to fund their nation’s elaborate social safety net. The Russians need a minimum $42/barrel to meet their budgetary obligations. Economies bleeding profusely at the back end, it is a game of who blinks first.
The biggest loser from the OPEC+ debacle in Vienna was the US shale oil producers and it is an existential threat for them. Only 16 US shale firms can operate fields at less than $35/barrel. Bakken shale company Whiting Petroleum filed for Chapter 11 bankruptcy and it may start the domino of widespread bankruptcy in US shale business. The shale players are lobbying hard and have put an aggressive campaign for sanctions against Saudi and Russia to cut the production and push crude prices up.
The pandemic has led to large scale layoffs all across the world. US unemployment rate has already risen to 4.4% and it is expected that by April end the unemployment may reach to 10 million. Permian Basin in the US, has been rocked by tens of thousands of job losses. If the oil price does not revive, more than half a million jobs in oil-rich states of the US in Texas, Oklahoma, and Louisiana will be at risk.
Almost one year back when the OPEC basket crude was around $70/barrel, Mr. Trump called on the OPEC+ cartel to lower their crude price. But this time it was a change in stance, huge concerns over unemployment and shale industry pressure were big factors; he came to the aid of shale producers on 2nd April, by talking up a production cut deal between Saudi and Russia by 10-15 mbpd. His tweets brought hope and buoyancy in the crude market, WTI crude jumped 30% to $27/barrel and then settled back to $25/barrel. But it is clear that — deal or no deal — US oil production is likely to fall. Prices are a long way below the level that shale producers need to break even, and the infrastructure of pipelines and storage tanks is quickly becoming overwhelmed. US crude inventories also reached its peak of 13.8 million barrels. US Department of Energy (DoE) said it is planning to make 30 million barrels of oil storage capacity immediately available, which would be available for US producers.
Mr. Trump met Oil industry representatives on 3rd April (Friday) and discussed the strategy to deal with the crisis. The meeting included CEOs from Exxon, Chevron, Occidental Petroleum, Devon Energy, Phillips 66, Energy Transfer Partners, and Continental Resources. As Trump was meeting with CEOs from the oil sector, the Saudis responded. They said they would support production cuts of at least 6 mbpd and would discuss those potential cuts with the rest of OPEC and Russia on 6th April (Monday) virtual meeting. The US, Russia and Saudi Arabia accounted for about a third of the 100 mbpd of crude produced last year. Putin said a cut to global oil production of about 10 mbpd is possible, but only if all major crude producers including the US join in the reduction pact.
Everything was on the table at the White House on Friday, when Trump discussed the US oil strategy to deal with the crisis. The executives discussed the possibility of US production cuts. Earlier this week, two Texas-based shale producers, Pioneer Natural Resources and Parsley Energy sent a letter to the Texas Railroad Commission, which regulates the oil industry in the state, asking it to hold a hearing in the hope of setting production quotas in the state.
The U.S. oil majors like Exxon, Chevron, Conoco Phillip, however, are hesitant. Coordinating production cuts raises obvious antitrust issues and it is simply not in the US oil and gas DNA to work together on an international level. Free market economics is a cornerstone of U.S. society and business. In addition, with solid balance sheets, they were in the lookout to pick up distressed assets from over-leveraged shale producers.
The other measures were also debated whether Trump should apply tariffs to Saudi oil imports, preventing Saudi crude from reaching its largest refinery in North America, the Motiva Refinery in Port Arthur, Texas (crude capacity of more than 636,500 barrels a day, with annual revenue of $24 billion); or suspending the Jones Act, which helps make crude shipped by domestic suppliers more expensive than oil delivered on foreign tankers, should the Kingdom not follow through with its own cuts. The shale lobby also proposed for US refineries to process only domestic crude for the next 60 to 90 days and not letting any foreign oil flow in.
However, oil industry’s most powerful lobbying organization, the American Petroleum Institute (API) and the American Fuel & Petrochemical Manufacturers, another lobby group, opposed restrictions on foreign oil, saying that the ability to buy from around the world, including those from the Middle East, are a key advantage for US refineries.
US and Canadian officials discussed the imposition of tariffs on Saudi Arabian and Russian oil imports if the two members of the OPEC+ group do not quickly reach a deal to end their price war. Canada also shared that they would be open to participating with OPEC+ in cuts to oil supplies and they would dial into the online OPEC+ meeting.
Shale producers are urging the White House to consider suspending US military aid to Saudi Arabia. The United States has tremendous leverage over Riyadh on this. Washington is the Kingdom’s ultimate security guarantor and has effectively kept the Saudi in power for decades. The arms deal between the US and Saudi of $350 billion over 10 years may also be a point of leverage for Washington.
In addition, the US oil lobby proposed for imposing further sanctions on Russian energy — or lifting existing ones if the Kremlin co-operates. The US recently imposed sanctions on a trading unit of Rosneft, Russia’s state-controlled energy company. On the other hand, Russia might consider cooperation with the US if Washington agrees to bring an end to Russian sanctions.
Vladimir Putin recently made a statement which jeopardized the potential for a deal when he accused Saudi Arabia of launching the price war to hurt US shale producers, in an apparent attempt to drive a wedge between Riyadh and Washington.
Saudi Arabia’s energy minister Prince Abdulaziz bin Salman and foreign minister Prince Faisal bin Farhan both attacked the statement saying these were “fully devoid of truth” and accusing Russia of “falsifying facts”. It looks like we might have a new diplomatic rift between Russia and the Saudis.
The latest update is that the much-sought virtual emergency meeting between OPEC and its allies scheduled for Monday (6th April) has been postponed. The meeting will now likely to be held on 9th April (Thursday), as tensions between Saudi Arabia and Russia mount. This will allow more time for negotiations among oil producers on crude supply cuts.
The upcoming “OPEC+ and Friends” meeting, whenever it happens, is going to be a very tricky one. There is a real possibility of the meeting failing as the targets that have been set are totally unclear. It appears that the US is invited and will likely attend. However, US oil companies will be unlikely to comply with any production cut.
Countries such as Libya, Iran, Iraq, Brazil, and Canada, are highly unlikely to agree at present to cut production. This is yet another reason that the OPEC meeting will likely fail.
COVID-19 pandemic has shaken the world economy, the magnitude is yet to be ascertained. Uncertainty, panic and lock-down policies had driven a huge drop in demand. When looking at the cuts in global refinery runs, the world has already hit levels of 17 mbpd or more. Downstream companies are cutting back on all production as demand from industry and consumers worldwide collapses. Lockdowns in more than half the world are having a major impact, hurting demand for oil, gas and other kinds of energy. Cutting 10+ mbpd of production is not a real solution and it could even cause markets to react negatively. When production cuts fail to send oil prices up, the fear in the market could hit historical highs, causing oil prices to fall further in the coming weeks.