STRENGTH TEST

The COVID-19 pandemic has already weakened many industries in dozens of countries and is threatening to continue its destructive effect. It seems that in this situation the only solution is to combine the efforts and economies of the leading countries to combat the common enemy - COVID-19. However, they clashed in the next struggle for oil profits, thereby completely destroying the already fragile oil market.

Nuclear explosion in the oil market

Disagreements of the largest oil producing countries regarding the extension of the OPEC+ deal and the subsequent threats coming from Saudi Arabia to increase production to a record 13 million bpd coupled with the coronavirus pandemic literally brought down oil prices by 45% from the indicator recorded before the collapse of the OPEC+ deal at the beginning of 2020.

On March 18, the price of Brent futures went down to $24.88 per barrel. At the same time, amid the statements to maintain the high level of production in Saudi Arabia and an increase in the US reserves, the price of futures fell to the lowest level since 2003—$24.52 per barrel. The price of WTI oil fell to $20.05 per barrel, i.e. to the minimum since 2002.

Despite the relative growth in the next days of quotations, the price of May Brent crude futures is $24.60 per barrel. Futures for WTI oil in May fell to $21.32 per barrel.

The current term of the transaction suggest a decrease in oil production by 1.7 million bpd to the levels of October 2018. And at the meeting of OPEC+ ministers, it was proposed to extend the deal until the end of 2020 with a decrease in oil production by another 1.5 mbpd. However, Russia rejected the extension of the deal proposed by the cartel. The failure of the negotiations contributed to the unleashing of a price war between Riyadh and Moscow - Saudi Arabia announced a 25 percent increase in production and unprecedented discounts for buyers from Europe, Asia and the United States.

“What we see is essentially the equivalent of a nuclear explosion for the oil markets,” Louise Diskon, an analyst at Norwegian consulting company Rystad Energy said. He expects prices to continue to fall until a balance point with cost is reached and production begins to decline.

“Extreme volatility is observed in the market as its participants try to assess the economic consequences of coronavirus and how they will affect the demand for oil,” says an analyst at Australia & New Zealand Banking Group Ltd. Daniel Hines.

Justifying the position of his country, Russian Deputy Minister of Energy Pavel Sorokin said that the impact of coronavirus on the fall in oil demand in February was quite significant. The OPEC + partners' proposed restrictions on oil production of 0.6-1.5 million barrels per day are a drop in the bucket and would not have had the necessary effect.

According to P. Sorokin, now there is a drop in oil demand in the amount of up to 15 million bpd, and in the near future the drop will reach 20 million bpd - this is not comparable with the proposed production restrictions.

Saving face

Russia, however, denies the very fact of a price war with Saudi Arabia, and blames the termination of the OPEC+ deal on Riyadh, which rejected Moscow’s offer to extend it for three months to assess the situation with coronavirus and its effect on oil demand. “It was a very big surprise for us to see even a hint that we somehow were involved in destabilising the market. Because our position is public, it was voiced. We support any efforts that could bring stability in this difficult period,” P. Sorokin said.

In addition, according to the Deputy Minister of Energy, the coronavirus also influenced the drop in oil prices. “Russia envisaged a scenario where oil prices would fall to $30 per barrel in the event of the collapse of the OPEC+ deal. Unfortunately, the OPEC member states adopted a decision rather than waiting until we analyse the situation. But coronavirus pandemic resulted in a fairly unexpected turn of events. We were expecting a gradual recovery in prices, because $30 was a worst-case scenario,” Sorokin said.

The simplest thing in the current situation is to look for responsible persons without solving the problems, which cannot be avoided, especially for the Russian economy. Even American leader Donald Trump pointed out that low oil prices have become a serious problem for Moscow, since oil is the foundation of the Russian economy. “All this is ruinous for Russia,” he said at a press conference in Washington, DC.

Indeed, experts believe that in two years Russia may face serious financial problems. Cheap oil is dangerous for the Russian budget and for the national currency. Since the beginning of March, the Russian ruble has fallen in price against the US dollar and Euro by more than 17% and by almost 16%, respectively. Of course, not only the pandemic, but also the sharp decline in world oil prices played an instrumental role in the depreciation of the Russian national currency. We also add that the international reserves of Russia, according to the Russian Central Bank, decreased by 5.1%f in March 13-20.

At the same time, Moscow is trying to save the face, promising to increase production to 0.5 million bpd and assuring the market of sufficient resources to cover the budget deficit at prices of $25-30 per barrel for 6-10 years.

Finance Minister Anton Siluanov assures that Russian oil companies have accumulated large reserves, so there is no reason to worry about this sector due to lower oil prices.

Meanwhile, according to the head of the state-owned Rosneft company Igor Sechin, low prices should not become an obstacle to the implementation of plans to increase oil production in order to maintain market share. “If you give up your market share, you will never return there again - this is precisely the point,” Sechin said. He is confident that low prices make shale oil production in the US inefficient, and therefore leaving the market of these volumes could return prices to the level of up to $60 per barrel by the end of 2020.

Meanwhile, unlike state-owned companies, which on occasion may ask for help from the state, representatives of the private sector are not so optimistic about the further development of the situation in the oil market. LUKOil Vice President Leonid Fedun estimated Russia's ability to increase oil production at just 0.3 million bpd, and then only for a limited period of time — in two or three years, production decline may begin in the country, Fedun said.

Victims of disagreement

The unexpected and sharp collapse in oil prices, which has already contributed to large-scale sale offs in other markets, creates serious risks for many economies from Latin America to the Middle East, as well as for the United States, where the oil sector accounts for a significant share of GDP. At the same time, not only the American shale oil sector was hit, but also oil production in Canada and in the North Sea.

Deirdre Michie, CEO of Oil & Gas UK (OGUK) Trade Organisation, said the latest oil price collapse put the UK oil industry in a “very fragile position."

According to OGUK, it is expected that companies engaged in exploration and production of oil and gas in the British part of the North Sea will reduce capital investments by 30%.

In the United States, according to industry analysts and representatives, US shale oil companies facing a threat of default will probably have to cut back on drilling and cut jobs if oil prices remain low for some period. But even these measures for many firms may not be enough to avoid bankruptcy.

“It is possible that 50% of companies involved in the exploration and production of oil and gas will go bankrupt in the next couple of years,” Scott Sheffield, CEO of Pioneer Natural Resources Co., said in his interview with WSJ.

According to WSJ, for the first time since 1972, the Texas authorities are considering the possibility of reducing oil production, which provides over 40% of all the US oil. According to WSJ, the leaders of a number of shale oil companies appealed to the regulator responsible for the development of oil fields in the state with a request to take measures to support the industry after the recent collapse in oil prices.

Shale oil companies have been hit hard by the fall in oil prices. They have significant debts and require higher prices for their oil than traditional oil producers. The issue has become so serious that American manufacturers have decided to strengthen cooperation with OPEC, which Donald Trump often accused of anti-competitive behavior. In particular, Texas Railroad Commission Commissioner Ryan Sitton held talks with OPEC Secretary General Mohammed Barkindo to discuss the situation.

On March 28, the operators of US oil companies asked manufacturers to limit oil production, as they are faced with insufficient storage facilities.

R. Seatton did not rule out the possibility of discussing the situation with oil prices with the Russian Minister of Energy and the Saudi Minister of Oil, but noted that he could not take any official action until the next OPEC meeting scheduled for June.

If American producers can reduce oil production, this could well soften Russia's position and return it to the negotiating table with Saudi Arabia.

Azerbaijan on the front line

Azerbaijan is also among the countries affected by coronavirus and falling oil prices. “Oil prices have more than halved being at $24 per barrel. Of course, this will lead to big losses for us. However, I believe that our efforts will let us get out of this test with honor,” President Ilham Aliyev said.

Meanwhile, analysts at Moody’s Investors Service predicted that a collapse in oil prices could weaken the national currencies of Azerbaijan, Russia and Kazakhstan, reducing the capital adequacy of banks with significant foreign exchange assets.

By the way, during the last meeting of OPEC+ ministers, Azerbaijan supported the proposal to extend the deal until the end of 2020 with an additional reduction, which is designed to ensure stabilization in the world oil market. And the Ministry of Energy is still hopeful to see the continuation of such cooperation.

“Disagreements in the positions of Russia and Saudi Arabia do not reflect the interests of other countries participating in the OPEC+ format, since coordination and solidarity were observed within the organisation. In addition, the expected recession in the development of the oil-producing economies should also be taken into account. All these three conditions inspire hope that the OPEC+ format will continue,” Zamin Aliyev, Press Secretary of the Ministry of Energy said.

According to Aliyev, the situation on the oil market at the end of 2014 ultimately led to the creation of the OPEC+ cooperation format. Over the three years of existence, OPEC+ member states have adopted a number of decisions that had a positive impact on the market.

“The market has always had a regulatory mechanism in place. Considering this experience and the current situation in the market, we can assume that in the end a compromise will be found and the oil market will recover. We are interested in a fair price in the oil market, and hope that the balance between supply and demand is restored, market volatility is eliminated,” Z. Aliyev said.

No limit to cooperation

Officially, the OPEC+ deal to limit oil production becomes ineffective on April 1, 2020, but given the current situation, it is simply pointless to wait for a consensus to be reached before Day X. Moreover, all countries are focused on combatting the coronavirus. Thus, starting from April, all 24 OPEC+ member states will become free from their obligations, using this opportunity for the subsequent increase in oil production. In this case, however, one should not forget that an increase in supply will inevitably entail a further decline in oil prices, and with falling demand in quarantine, even China will not be able to save the situation.

Analysts at Bank of America believe that amid falling demand and increasing supply in the oil market, oil reserves could grow by more than 900 million barrels in the second quarter. This may contribute to further price reductions.

“The level of $20 per barrel can easily be hit by mid-April,” R. Ramachandran, director of the Indian oil refining company Bharat Petroleum Corp. said.

Some traders note that a recent drop in prices is enough to stimulate purchases to replenish reserves with cheap raw materials. However, this demand will continue only until customers fill their stores.

Bob McNally, president of Rapidan Energy Group, expects prices to drop below $10, as there will be no buyers or oil storage facilities. Other experts suggest a fall in prices until production for a significant share of producers becomes unprofitable. Goldman Sachs predicts $20 per barrel in the second quarter. Citigroup said the bank’s baseline scenario assumes an average Brent price of $17 per barrel in the second quarter, and a price drop to $5 per barrel in the worst-case scenario. Energy Aspects experts see the risk of lowering the cost of Brent to $10 per barrel in April, while expecting that during the rest of 2020, it will be above $20 per barrel.

In short, the forecasts are disappointing, but predicting oil prices is a thankless job - as practice shows, they do not always hit the target. The oil market has been tested more than once by low prices. It is encouraging that this time there will be a way out and a new OPEC+ deal will be concluded, but on much more stringent conditions to ensure that the price returns to the level of $50 per barrel.