The least expected happened on Friday. The proposed reduction in OPEC+ production was rejected by Russia. It would have taken the combined cut up to 3.6 mbpd from the 2016 level. The proposal, based on the recommendation of the Joint Ministerial Monitoring Committee, pushed for an extra 1.5 mbpd decrease in the group’s production level extended from the originally planned end-of-June date until the end of December 2020. The COVID-19 outbreak has had an adverse effect on global oil demand growth, which is now expected to increase by only 480,000 bpd in 2020, down from 1.1 mbpd estimated in December, the Conference noted. The proposed reduction in oil output would have been applied pro-rata between OPEC (1.0 mbpd) and non-OPEC producers (500,000 bpd).
As the demand side destruction of the coronavirus is a guestimate at best it would have been impossible to predict whether the recommended reduction was sufficient to prevent global oil inventories from significantly building. The Russian decision, however, to reject the new deal created a supply shock, which, together with the demand destruction sent oil prices into tailspin. The decision was so unexpected and possibly took OPEC by such a big surprise that there was no press release on Friday afternoon. The move effectively means that the current output deal will expire in just three weeks’ time and from April 1 onwards the participating nations will be free to produce as much as they want. The Saudi energy minister, Prince Abdulaziz bin Salman, told reporters on Friday that” I will keep you wondering” when asked if his country would increase oil production after March.
It, however, only took two days to find out what the new Saudi strategy is – it is called “let the battle commence”. The Kingdom has slashed its global Arab Light official selling prices; by $6/bbl to Asia, by $7/bbl to the US and by $8/bbl to North West Europe, one of Russia’s main market. The war against the coronavirus is turning into a war for oil export markets. The Kingdom is also anticipated to significantly increase production from next month onwards. The fall-out between the two heavyweight producers caused an earthquake in the oil market, the extent of which cannot even be measured on the Richter scale. Both WTI and Brent fell around $14/bbl from Friday’s settlement levels. Both contracts are in deep contango now. Heating Oil and RBOB came dangerously close to the $1/gallon mark and it will take a brave man to bet against penetrating this milestone. Goldman Sachs and Morgan Stanley have both revised their Brent price forecast for 2Q 2020 to $30/bbl and $35/bbl respectively. Demand for safer investment vehicles have jumped considerably from Friday. Gold has broken over the $1,700/ounce mark for the first time since 2012. The yield on the US 3-year Treasury is 0.31% this morning. It was 1.5% back in January. As understandable panic sets in the market is staring into the abyss.
Russia basically did last week what Saudi Arabia tried in 2014 – claiming market share back whatever the consequences are. The Saudi reaction and the consequent carnage, however, must surely come as an unpleasant surprise for Russia and it might re-think its strategy. It is worthwhile to have a look at what the world’s second biggest oil producer stand to lose and gain from the decision not to participate in further output cuts. The biggest winners of its decision are domestic oil companies who have long argued that output restrictions limit their abilities to develop new oil fields. Russia will also take heart from the fact that the dive in oil prices will likely put US shale companies in an almost impossible and difficult financial positions – few of them are likely to go bankrupt. The share price of EOG Resources, for example, fell to $55.30 on Friday. It was nearly as high as $90 at the beginning of the year.
This is where the positives stop from the Russian perspective. If you assume that the price difference between agreeing and rejecting last week’s recommendation is $25/bbl then Russia stands to lose a considerable amount of money by not endorsing the proposal. The current Russian production quota is 11.05 mbpd and with the new cuts it would have probably been around 10.75 mbpd. With Russian oil prices at, say, $55/bbl the daily revenue would stand at $590 million. At $30/bbl and at 12 mbpd, if that, the daily revenue drops to $360 million. Of course, this fall will somewhat be mitigated by the weakening of the rouble, which has deteriorated against the dollar in recent weeks, but its impact will not be protracted.
There will come a point when the negative consequences of Russia’s decision will become unbearable for the instigator. In the light of this morning’s price crash this point might not actually be that far away. President’s Putin approval rating has dropped 24% to 35% between November 2017 and January 2020, according to surveys. As the country’s economy has been slowing (it only grew 1.3% in 2019) the president has pledged to spend $65 billion on social welfare initiatives in the next 5 years, something that will be difficult to keep with oil prices at around $30/bbl and possibly lower.
In the meantime, the coronavirus is spreading all over the world suggesting extreme economic hardship for the weeks and months ahead. In Italy 16 million people have been quarantined. Death toll rose 133 in one day. The number of confirmed cases in the US jumped above 500. In the UK supermarkets started rationing products whilst coronavirus cases in Germany are now well over 1,000. Although reported cases in China has been the lowest since January the peak in other parts of the world is still far away. European stock markets are tanking and US futures have quickly reached their daily down limits. Under the current circumstances it is hard to recommend anything other than staying away from risky assets for the time being.