While the crisis, caused by the spread of coronavirus is not all over yet (and unlikely to be for quite some time), we will be moving along the curve, with experience which may expedite the process of transformation and transition to a new market model, writes Valdai Club expert Slawomir Raszewski.
The sudden rupture of a three-year alliance between Russia and the Organisation for Petroleum Exporting Countries (OPEC), the so-called OPEC+ format, starts a new period of uncertainty and volatility on crude oil markets and beyond. At the time of writing this op-ed, developments are unfolding and – in addition to the oil dimensions – complicated by the COVID-19 crisis adding to an economic slowdown, possibly a new financial crisis. Yet the ensuing, so-called oil price war attributed to OPEC’s most potent member state, Saudi Arabia, and the Russian Federation has already resulted in serious, already-historic consequences on global commodity markets. The intensification of the crisis caused by the coronavirus pandemic is likely to have further negative consequences for markets. Having said this, the discord between the world’s two largest national exporters of petroleum is likely to have immediate effects on US shale producers and, more broadly, the unconventional hydrocarbon production industry, with many unsustainable businesses imploding. The politics of oil, as manifest in the oil price war, is likely to further exacerbate the market turmoil which has already been experienced as the key producers continue flooding the markets with oil at the cost of shale production. Weaker and more highly-leveraged companies will be particularly heavily affected by low oil prices. At least in the short term, until OPEC+ returns to negotiations or alternative oil output alliances are formed, oil markets will provide even low prices yet, in what is now increasingly a demand-stricken world economy. Significantly, conventional wisdom suggests that in the long run, the collateral damage of the geopolitics and the low markets is likely to be inflicted upon investments in clean energy projects and, more broadly, long-term action against climate change; the repercussions of the double-edged sword of pandemics and oil geopolitics may well produce alternative ideas about the future world economy, as oil has been the primary driver for decades.
US shale oil producers should be credited for their unprecedented contribution to the global oil pool. In 2019 alone production from tight oil resources in the US reached 7.7 million barrels per day of crude oil, which equalled about 63% of the country’s total oil production that year. The sheer extent of shale production in America positioned the US producers alongside Saudi Arabia and Russia as the world’s largest petroleum production trio, driving international oil prices down and invalidating the shock of triple-digit prices in the early 2010s. OPEC’s decision in November 2014 not to cut production amid plunging prices exposed the organisation’s ability to regulate prices, demanding a new format to prop it up. Initiated in 2016, OPEC+ brought the group together with key producers from outside the organisation – most importantly Russia – to sustain the group’s institutional objective of policy coordination to secure fair and stable prices for petroleum producers. The subsequent OPEC+ gathering had been tactically convenient, ensuring the broader arrangement while providing a new role for Russia as an indispensable decision-maker in the global production of oil, an issue which author of this comment pointed out at the time. Russia’s involvement secured the rise of oil prices, saving the key exporters’ balance sheets while allowing Moscow to significantly increase its already-substantial National Wealth Fund. This time the context is very different. The oil price has fallen to the low $30s at the time of writing, against the backdrop of the crisis which has erupted as a result of the coronavirus pandemic. The reduction of global oil demand as a direct result of the pandemic coincided with the fallout of the OPEC+ format, leading to a price war between Saudi Arabia and Russia, which, in turn, has led to an increase in the global oil supply.
The prices are likely to recover unless either Russia or Saudi Arabia formalise their positions in the oil price standoff. Should either of the two oil producers seek to proceed to ‘stage two’ of the war, then coordination with other market players – possibly some of OPEC’s Middle Eastern producers or even beyond the region – might follow. National oil producers in Saudi Arabia and Russia control only fractions of world production, which itself stood at less than 81 million barrels of oil per day in 2019. There is, at least in theory, a lot of bargaining power among other producers that might want to align with Russia or Saudi Arabia. It is, however, unclear to what extent it is feasible in the case of Iran and Venezuela, owing to the financial cost of such alliances. National producers with higher production costs and without the cushion of adequate national wealth funds might be at risk in such alliances. Some national producers from the Middle East would be better-equipped to join in the oil price ‘battle’ due to other stakes at play.
With respect to the short-term perspective of the next months, it is not unreasonable for the two sides, Saudis and Russians, to return to the negotiation table. OPEC itself has been ineffective due to the underlying market-share dynamics. Indeed, the Organisation’s November 2014 decision not to cut the supply opened a way for a strategic alliance with Russia. A prolonged standoff, coupled with lesser demand in the world economy, is likely to lead to the convergence of the interests of the key producers. There has been a significant impact on the demand side, led by China’s reported loss of oil demand, at 4 million barrels per day (coupled with the impact of the economic slowdown elsewhere).
Oil price wars are geopolitical in nature with consequences having impacts on markets. Three points concerning geopolitics, markets and the environment should be considered here. First, geopolitical concerns continue to be on the rise due to the redefined business model the oil trade is based on. National Oil Companies (NOCs) with their resource-driven power are ultimately capable of price manipulation through supply, a strategy beyond the supermajors’ capabilities. In the last decade, Europe-based International Oil Companies (IOCs) have effectively started diversifying away from their core oil and gas business and are moving towards alternative sources of energy in search for a new business model. NOCs to a large extent have sought to cement their positions as petroleum companies in the world economy, which is still predominantly fuelled by fossil fuels.
Markets are likely to remain low this year and in early 2021 in anticipation of an agreement between the producers/exporters. If sustained, the oil price war between Saudi Arabia and Russia holds the potential to affect US shale producers. There has been extensive leveraging amongst middle capitalisation shale producers. Low oil prices on markets will affect those producers who failed to deleverage. Bankruptcies are highly likely amongst some mid-cap companies with drying up financing (equally, banks too exposed to the energy sector are equally threatened and it is still unclear to what extent government support will be available and acceptable to relieve the situation).
The coronavirus epidemic in China had indirectly reduced the country’s emissions – a result of diminished demand – due to the shutdown of businesses and, after the spread of COVID-19 to Europe and the rest of the world, an economic slowdown which is likely to have an effect on emissions. However, the low-price environment means that a dramatic drop in oil demand is very likely and may have negative longer-term implications, threatening long-term climate action by undermining investments in clean energy. The proof will be in the pudding, though, depending upon changes on the markets in the aftermath of the pandemic.
The on-going pandemic crisis is likely to be more dangerous for markets than the oil plunge. We are in the midst of unprecedented developments which, while difficult to compare to historical examples due to the rise of technology and analytical capabilities in the last decade or so – may well be compared to the 2007 Financial Crisis or 9/11. The spread of coronavirus has virtually brought travel and markets to a halt. While it is not all over yet (and unlikely to be for quite some time), we will be moving along the curve, with experience which may expedite the process of transformation and transition to a new market model. It does not, immediately, mean an embrace of non-hydrocarbon energy as it is the dominant source of energy security in the foreseeable future. What we may well be witnessing, though, is a slow if not painstaking transition to more sustainable and emancipated economies in the era of pandemics.