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By Angélique Mounier Kuhn
A historic agreement. Under pressure from the United States, the Organization of the Petroleum Exporting Countries (OPEC) and other major producers of black gold, including Russia, agreed on Sunday 12 April to a record reduction of 10 to 15 million barrels per day starting from 1 May. The partners thus hope to raise oil prices, which have fallen to their lowest level for nearly two decades, in the midst of a global pandemic and against the backdrop of a price war between Moscow and Riyadh. The drop in prices has been particularly hard on the oil majors and shale oil producers in the United States, who have been forced to trim down their operating costs.
“Great deal for all,” boasted U.S. President Donald Trump on Twitter. “This will save hundreds of thousands of energy jobs in the United States.” An optimism that is not shared by Laurent Horvath: “The coronavirus pandemic has spread throughout the world, causing an unprecedented slowdown in mobility and freight transport. Although historic, this drop in production appears insignificant when compared to the collapse in demand caused by the crisis,” says the energy geo-economist. And it remains to be seen whether all partners will really honour their promises to reduce production.” Interview.
Are oil prices falling because of a demand shock or a supply shock?
Both. The COVID-19 pandemic has wiped out a portion of demand. According to estimates, in just a few weeks demand fell by 25 million barrels a day out of a total consumption of 100 million, a drop of 25 to 30%. This unique situation in the history of oil is forcing producers to stockpile their production.
According to Rystad Energy, more than 75% of the world’s storage capacity is already being used and, at the current rate of overproduction, it could soon be filled to the brim. Ocean tankers are also used for storage, and shipping prices have consequently shot up. What will happen when storage capacity is all used up? In the worstcase scenario, some producers could be forced to sell oil below zero, in other words, pay to get rid of their production. Other scenarios have crude prices stabilising around $10 or $20, as Goldman Sachs predicts.
How long can Russia and Saudi Arabia hold out with oil prices so low?
Saudi Arabia and Russia could each hold out for a few years. Both have sovereign funds. Russia’s is worth $150 billion. Extraction costs are very low there, and the country needs a price per barrel of $42 to balance its budget. Saudi Arabia’s sovereign fund is worth $500 billion, and extraction costs in Saudi Arabia are also very low, around $5 to $10 a barrel. But the Saudis would need a price per barrel of $80 to balance their budget. With their sovereign fund, they could hold out for one or two years.
How are things looking for the big oil companies?
Major companies such as ExxonMobil and Chevron in the US, Shell in the Netherlands, BP in the UK and Total in France have already started cutting operating costs, announced lay-offs and halted certain investment plans. They have also announced a suspension of their share buyback programmes. But they are doing everything they can to maintain their dividends in order to hold on to investors. Chevron, for instance, planned to distribute $75 billion over the next five years. It is unlikely that the company will follow through with that commitment. In February, these companies were counting on a price per barrel between $60 and $70 to finance exploration, new projects and dividends. Since then, everything’s fallen to pieces.
What about smaller shale-oil producers, whose fast growth has helped the US regain its position as the world’s leading oil producer?
They’re really struggling, but the problem really started back in 2019: 42 of those companies went bankrupt last year, with 37 occurring in the fourth quarter. The oil they produce is expensive, with an estimated average cost of $52 a barrel. It is also poor quality, so refineries buy it at a discount of between $5 and $20 a barrel. With the price per barrel at $25, those companies are losing a lot of money. And they are especially vulnerable because they have to repay $40 billion of debt this year.
If the shale bubble were to burst completely, the effects would be felt around the world. But the White House is set to launch a stimulus plan to bolster the sector by injecting $2 trillion into the US economy. It remains to be seen who the lucky ones will be and whether the production of 9.3 million barrels a day can be maintained.
Some commentators believe the Russians wanted to wipe out US shale oil...
That’s totally plausible. America’s energy-dominance policy allows the US to hinder production in Venezuela, Iran and Russia. The last straw was certainly the new US sanctions against Rosneft Trading, the Swiss subsidiary of the Russian oil company Rosneft, which sells Venezuelan oil. With the composure of a skilled chess player, Russia decided it was time to challenge the energy dominance of the US.
In that case, why did Russia make a 180-degree turn, finally agreeing to reduce its production?
Because of pressure from the United States. Donald Trump must preserve oil jobs in the USA, which led him to open talks with Vladimir Putin. Negotiations between the two countries undoubtedly went beyond the oil framework and an exchange in other areas must have taken place, such as a loosening of the sanctions against Moscow.
Once the health crisis is over, will the economic recovery cause global demand to rise again?
Once the pandemic is under control, it’ll take a few months to absorb the current production surplus and rebalance stocks. During that initial phase, prices will likely remain low and will help the global economy get back on its feet. During phase two, assuming that the global economy picks up again, and that US shale oil production is considerably reduced, or that many producers are considerably weakened, prices could quickly skyrocket. But if shale oil production picks up again, prices will go back to where they were in 2019.
Such extreme up-and-down movement is highly destabilising for investors and governments alike. Not even the biggest companies are spared. In five years, ExxonMobil lost over half of its market value. Oil has become a ticking time bomb, and, looking more than 18 months down the line, investment risks will remain very high and ill-defined. The resilience of the biggest companies should provide a good indication of how the sector will fare.