Valdai Club

Over the next couple of weeks, oil prices, according to our forecasts, will hover in the $25-30 range. This price is not especially critical for such oil-producing countries as Russia, where the production cost remains quite low. For Russian companies, the production cost of current wells is about $4, and the same is spent on transportation, so the cost of what’s being sold is $7-10.

In any case, matters will become critical in the event that the price of oil sinks to approximately a third of what it is currently. If oil prices remain lower than US $35 until this fall, it will have a negative impact on many oil-producing countries: a number of companies with high production costs will leave the market.

Currently, the US is extremely concerned about the situation in the oil market. Oil prices remain highly volatile in the wake of the collapse of the OPEC+ agreement. The oil price drop is already hitting the American companies that produce shale oil (the average useful cost of producing shale oil is $45), they are likely to put an end to production activity among small and heavily indebted companies. Before 2024, companies will have to pay about $90 billion in debt to service credit lines opened when oil prices were high. The number of operating drilling rigs has fallen to 664, the lowest level in 2 years. Most companies have cut capital costs, and even the largest companies have begun firing employees. Texas Occidental Petroleum Corp. warned employees that in the near future it will sharply reduce wages: the income of ordinary employees will decrease by 30% from April 1, and among top management by 68%. The executive director of the company will swallow a 81% salary cut. American investors are worried about reduced demand due to travel restrictions and the closure of state borders because of the coronavirus. Oil companies may sell oil at a loss to cover recurring costs, but this is only possible in the short term.

How can the US influence the market? One option is to put pressure on Russia and Saudi Arabia to reduce oil production. The United States intends to take diplomatic steps to force Saudi Arabia to abandon its plans to sharply increase production. Saudi Arabia (which has a very low production cost) wants to grab a large market share at a discount. Let us note that the Kingdom operates with an annual deficit, and in order for the budget to break even, oil should cost $84 per barrel or more. Energy makes up about 80% of the country’s total exports and accounts for about 65% of budget revenues. The currency of Saudi Arabia – the rial, is tightly tied to the dollar, so the country’s authorities cannot replenish the budget by adjusting its rate. US authorities have already begun negotiations with Saudi leaders, but so far these remain inconclusive.

The United States plans to negotiate with Russia using restrictions and sanctions. The Russian budget is planned with a surplus, at an oil price of $40 per barrel. There are gold and foreign exchange reserves worth over half a trillion US dollars, and the ruble is floating, unlike the Saudi rial. The low price will allow companies that have new fields to increase oil production, but may adversely affect long-term capital-intensive investment projects.

The United States has already introduced restrictive measures against Venezuela and Iran. Sanctions apply to those who want to work with companies on the US sanctions list. By expanding this list, the United States can set up a large foreign business against itself and exacerbate the geo-economic situation. The idea of introducing an embargo on oil imports from OPEC countries also lacks logical meaning in the long term.

The second option for influencing the market is domestic support measures. The US authorities are preparing a package of anti-crisis measures to support American oil and gas companies, including large federal loans at a low rate, hoping to refinance current loans and reduce bankruptcies. In any case, the current market situation may lead to the bankruptcy of 70% of US shale oil producers.

Today, the low oil prices are beneficial for the world’s largest consumers, primarily for China, which is about to recover from the coronavirus and resumes its industrial growth rates. According to our forecast, prices of around $50 per barrel will return no earlier than in the fourth quarter of this year. We are also seeing a sharp drop in prices on the physical oil market. This is also due to the fact that the market is currently oversaturated with oil. According to various estimates, in the first two quarters, the glut could total 1 billion barrels. The global economy is in its worst state since the global financial crisis; it is predicted that coronavirus will lead to at least 10% reduction in global oil demand.