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Clash of Titans: Saudi Arabia and Russia
OPEC+: After five hours of polite but fruitless negotiation, in which Russia clearly laid out its strategy, the talks broke down. Post that, oil prices have struggle to recover and are down over 30%. A three-year pact between OPEC and Russia ended in acrimony after Russia refused to support deeper production cuts to support prices hit by the coronavirus outbreak. OPEC responded by removing all limits on its own output. OPEC has been effectively cutting production by 2.1 million bpd, as Saudi Arabia has been reducing its own output by more than agreed. Hell broke over the weekend as oil prices plunged by 25% in single trading session after OPEC and Russia started an outright oil price war which leading to the biggest percentage drop since January 17, 1991, at start of first Gulf War and lowest price since February 12, 2016.
Prices were already under pressure before the OPEC+ alliance appeared to fall apart, with demand fears pushing both grades into bear-market territory earlier this year. The prospect of another price war is spooking traders who will remember the crash that began in 2014, when an explosion in U.S. shale production prompted OPEC to open the spigots in an attempt to suppress prices and curtail shale output. That strategy ended in failure, with shale producers proving too resilient and Brent crude tumbling below $30 a barrel in 2016 amid a global glut. It was that crash that prompted OPEC to club together with Russia and others to curtail output and help shore up their oil-dependent economies.
Russia seemed determined to go against Saudi’s wish for further output cut, as Russia is certainly betting that price crash will cause U.S. production to crash, helping restore its dominance. Remember, Russia is largest non-OPEC participant in OPEC+ that that has resulted in the withholding of production and exports of crude by these countries since the plan was first implemented in December, 2017. Russia's efforts are intended to counter U.S. shale producers and push back against U.S. sanctions targeting the Nord Stream 2 gas pipeline that connects Russia and Germany as Kremlin as decided to sacrifice OPEC+ to stop U.S. shale producers and punish the U.S. for messing with Nord Stream 2. The White House has also targeted Venezuelan business of Russia’s state-oil producer Rosneft.
Output refusal seems like best outcome for long term as deeper OPEC+ output cuts would help protect U.S. shale producers while reducing stimulus for faster oil consumption growth. It is not clear how either would help Saudi Arabia, Russia or rest of OPEC. Russia’s refusal to agree to deeper production cuts is decision to allow prices, rather than OPEC+, to rebalance market. In longer run, it is the right decision, for Saudi Arabia and OPEC as well as Russia.
Saudi Message: Saudi Arabia is set to raise oil production next month, in an apparent attempt to put pressure on Russia after Moscow refused to join other nations in curbing output to support the price of oil. Reports suggest that Saudi Arabia can increase oil output next month, well above 10MBpd to 12Mbpd to punish Russia, this means as much as an extra 1.3 million bpd could flood the market next month - just as demand is taking a major hit from the economic fallout of the global coronavirus epidemic.
With oil demand already plummeting due to the economic impact of the coronavirus, traders forecast that prices will go even lower. The oil market is now faced with two highly uncertain bearish shocks with the clear outcome of a sharp price sell-off. Forthcoming flood of supply, overwhelmed inventories and coronavirus-led demand shockcan see price could to a tumble to nadir of $20 a barrel, lowest oil prices of the last 20 years. What still has to become clear is what do crude oil exporters do in response to the Saudi action, beyond the short-term move of also cutting prices?
Also, will importers actually buy more crude, or switch their supplier mix in response to cheaper oil? The coronavirus is still hitting demand and it's likely that storage tanks will soon be filling up, with only China likely in a situation where it can meaningfully add to its strategic inventories. OPEC+ members can choose to raise output from Q2 onward, a wave of oil will be unleashed onto markets.
We expect to see Saudi Arabia, the UAE and other large producers in OPEC increase production over the rest of 2020 as they return to a market-share strategy rather than price targeting. Inventories will consequentially surge, and as OPEC+ pursues this market share fight, market balances to stay stuck in surplus for at least the first three quarters of 2020 and we can see the lowest oil prices of the last 20 years, implying that the price could tumble to a nadir of $20 a barrel also.
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