“We’re going big”. Those were the words used by President Trump as his administration unleashed a near $1 trillion offensive against the coronavirus. The unprecedented package includes tax holidays, loans and direct cash payments to American citizens. Other Western governments followed suit in announcing aid packages yesterday as they too went through their ‘whatever it takes” moment. A further lifeline was provided by the Federal Reserve which pledged to buy short-term corporate debt. Only time will tell whether this stimulus bazooka will ward off a global recession, but for now this liquidity boost was lapped up by market players.
The Dow Jones rebounded 5% on Tuesday a day after it suffered its biggest ever one-day points loss. This recovery, however, was lost on the energy complex. Oil plumbed new multi-year lows yesterday. Brent settled below $30 for the first time since 2016. The European crude benchmark finished the session $1.32/bbl lower at $28.73/bbl while its US counterpart lost $1.75/bbl to close at $26.95/bbl. Additional downside pressures will be forthcoming as the oil market succumbs to a double-whammy of demand destruction and surging supply. The drop in global oil demand is expected to peak next month with some putting the figure as high as 10 mbpd when compared to the same period last year. All the while, Saudi Arabia is pushing ahead with its market-share strategy. Yesterday, it hinted that its crude exports will scramble above 10 mbpd over the coming months.
All in all, the mother of all supply surpluses is in the making. No surprise, then, that banks are rushing to reiterate their bearishness. Goldman Sachs yesterday slashed its 2Q20 Brent price forecast to $20/bbl. Such is the prevailing bearish sentiment that a pullback in US oil inventories is falling on deaf ears. Overnight, the API reported that stocks in all major US petroleum categories fell last week yet this is failing to lift oil prices. In other words, we are in a dangerous era in which supportive news counts for nothing.
Saudi Arabia 1 – 0 Rest of the World
In war, there are winners and losers. So, who will emerge victorious from the latest oil skirmish? Russia’s refusal to back extra OPEC+ cuts has left its three-year alliance with Saudi Arabia in tatters. The two oil superpowers have since decided to pump full bore and in doing so triggered a price war. At first glance, the non-OPEC heavyweight seems better placed to withstand low oil prices. Last week, Russia’s finance minister said it could weather oil prices of $25 to $30 for between six and 10 years. What is more, he hinted that it could tap the country’s Sovereign Wealth Fund, which holds more than $150 billion, to ensure financial stability.
In contrast, high budgetary commitments mean Saudi Arabia is at a fiscal disadvantage. Riyadh needs oil at around $80/bbl to balance its budget compared to $40/bbl for Moscow. Nevertheless, the Saudis have a potent weapon at their disposal, namely spare production capacity. As the long-time purveyor of global spare capacity, Saudi Arabia is reopening the oil spigots after having done most of the heavy lifting in curbing supply. The kingdom signalled that it will boost oil supply to a record high of 12.3 mbpd in April, about 2.6 mbpd above the current level. Furthermore, Saudi Aramco has been instructed to launch a programme to boost production capacity for the first time in more than a decade Put simply, the Saudis are in for the long haul.
All the while, Russia has also pledged to boost production. Yet it will struggle to meaningfully lift output from current levels. Russia’s oil and condensate supply is running close to capacity at a 12-month high of 11.29 mbpd. It claims to be able to raise output by a further 500,000 bpd but most see the true figure as closer to 200,000 bpd. In short, the Saudis are partially able to offset the drop in revenues caused by the price slump by significantly boosting output. The same can’t be said for the Russians. Little wonder, then, that the Saudis are on the offensive. OPEC’s de facto leader has offered crude oil at steep discounts and chartered a host of supertaskers in a bid to flood the world with cheap oil. What is more, it is targeting buyers of Russian crude in Europe and Asia. All in all, it’s a case of advantage Saudi Arabia in the battle for market share.
Aside from the Saudi-Russia tussle, others stand to gain from the new status quo. For instance, the low-price environment is a fiscal boon for oil-importing countries. Among them is China, the world’s biggest crude importer. China’s oil inventories swelled earlier this year after a virus-induced pullback in refinery throughputs but its crude intake has recently rebounded. Elsewhere, India is also poised to take advantage of low oil prices, in this instance to bulk of its strategic stockpiles. The same is true for the US. President Trump vowed to fill the country’s Strategic Petroleum Reserve to the top. Its strategic reserve has the capacity to take an additional 77 million barrels of crude and stock fills are set to last several weeks.
Yet others have far less reason to cheer. Heavily dependent oil producers are facing sharply reduced revenues and will therefore struggle to patch holes in their budgets. They include several OPEC and non-OPEC nations. However, there is one notable exception. Mexico is famed for its annual oil hedging programme which is the largest of its kind. It locked in its 2020 crude exports at an average of $49/bbl earlier this year at a cost of $1.15 billion. This now seems like money well spent given the new norm of $30 oil. Mexico is one of the few producers sheltered from the steep drop in crude prices. For the majority, painful times lie ahead as the Saudis flood the mark with discounted oil. But don’t expect any sympathy from the kingdom for all’s fair in love and war.