For the last three years, Russia has been working with the Organization of Petroleum Exporting Countries (OPEC) on production schedules that served to stabilize oil prices. But the advent of the COVID-19 virus has led to a dramatic decrease in petroleum consumption globally. OPEC, led by Saudi Arabia, proposed some dramatic production cuts in order to prevent a further decline in prices. But Russia refused to go along with the production cuts, and Saudi Arabia has retaliated with an unprecedented increase in oil production from 10 million to 12 million barrels a day. The act was the opening salvo in what we call a price war, where Saudi Arabia intends to undercut other producers and draw their customers away. It is a risky strategy because Saudi Arabia is betting that it can weather the loss of revenues better than other producers. At some point, producing oil for export will become unprofitable for some producers. The Middle East Eye reports:
“The break in a three-year alliance between the Saudi-led oil cartel and Russia to support prices may be temporary. The moves over the weekend may well have been part of a negotiating chess game, and the Saudis and Russians can still reach a compromise. But if the collapse is lasting, oil executives say there is nothing to stop oil prices from tumbling to the lowest levels in at least five years, the New York Times reported on Sunday.
“’If a true price war ensues, there will be plenty of pain in the oil markets,’ Badr Jafar, president of Crescent Petroleum, a United Arab Emirates oil company, told the Times. ‘Many will be bracing for the economic and geopolitical shocks of a low-price environment.’
“The production increase and deep discounts mark a dramatic escalation by the Saudis after Russia rejected an ultimatum on Friday in Vienna at the Opec+ meeting to join in a collective production cut. After the talks collapsed, Russia indicated countries were free to pump-at-will from the end of March.
“With jet fuel, gasoline and diesel consumption rapidly decreasing amid the economic impact of the coronavirus outbreak, the energy market now faces a simultaneous supply-and-demand shock.
“After the failure in Vienna, Riyadh responded within hours by cutting its so-called official selling prices, offering record discounts for some of the crude it sells worldwide, according to a copy of the prices seen by Bloomberg News. Aramco has set the prices, but the official communication to clients is likely to come on Monday, a person familiar with the matter said.”
Brian Sullivan of CNBC assesses the economic impact of the price war on American producers:
“Many industry people I spoke with over the weekend expect oil to open trading in the $30 dollar range, if not worse by week’s end. That’s very bad news for Texas, North Dakota and anyone still left invested in oil and gas stocks. Shares of Chevron are down 20% in 2020, making it the best performing energy stock in America. Most are down 30%, 40% or even 50% since January 1st. The S&P Oil & Gas ETF (XOP) is down 33% this month.
“The industry is facing a three-sided attack: falling prices, a move of institutional investors to divest from fossil fuel companies, and crushing debt loads.
“Debt is the problem. The U.S. oil and gas industry has about $86 billion of rated debt due in the next four years, according to Moody’s. Nearly all of that debt is either junk rated, or rated just above junk. Fifty-seven percent of that is due in just the next two years. As oil prices fall and credit markets tighten, many companies won’t be able to refinance their debts or extend maturities.”
Both Saudi Arabia and Russia fear the productivity of the US fracking potential which has propelled the US into the spot of being the top oil producer in the world. Their objective is to throttle the fracking industry to eliminate the competition. But they also wish to slow down the transition to renewable energies and an oil price of $20 a barrel would make many of those alternatives unprofitable. Consumers all over the world will benefit from the lower prices and that result will mitigate some of the costs of containing COVID-19. The actual winners and losers will not be fully known until the process plays out completely.
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