As the economic contagion of coronavirus spreads, Russia has abandoned OPEC+. In response, Saudi Arabia flexed its huge crude oil output muscles, opening its taps and backing Iran further into an economic corner
The latest meeting of the crude oil producing nations cartel OPEC plus Russia (OPEC+) ended in dramatic fashion when Saudi Arabia and Russia failed to agree on a strategy for crude oil pricing.
With impacts from the Covid-19 coronavirus outbreak slowing economic growth – lowering manufacturing output from China and curbing travel while spreading across the globe – crude oil demand had dropped by an estimated 1M b/d in the lead up to the OPEC+ meeting in early March.
With this economic uncertainty as backdrop, it was widely expected that OPEC and Russia would continue to work together to manipulate markets, agreeing lower crude production to support oil price stability.
The outcome came as a surprise.
Leading up to the meeting, the big debate among analysts was the size of the cut, would it be 1M b/d or 1.5M b/d? The accepted position was that Russia required higher crude oil prices to maintain economic growth. As such, virtually none of the crude oil analysts forecast Russia would reject the Saudi proposal to cut crude oil production.
But that argument overlooked the years of austerity introduced by President Putin and the government’s dramatic increase in ability to access Arctic crude oil and natural gas and deliver to the global market via Sovcomflot. The expansion of crude oil production in Russia has lowered the marginal cost of producing an extra barrel of Russian crude oil to US$2.98/bbl, according to the Wall Street Journal.
This is lower than Saudi Arabia, which was long regarded as having the lowest marginal costs of US$3.00/bbl. The marginal cost of producing an extra barrel of US shale crude oil is US$5.85/bbl. Russia’s rejection of oil price stability production cuts allows it to challenge the growing influence of US shale oil on the export markets.
This was the policy followed by Saudi Arabia in 2014, when it tried to kill off US shale oil production by flooding the market and to make as much money as possible from crude oil while there is still a market. After all, there is no point in having the world’s largest reserves of crude oil if no one wants to buy it in 30 years’ time.
The speed and intensity of the Saudi reaction has caught analysts off guard, too. Not only has Saudi Arabia stated that it may increase production to 12M b/d, flooding up to an extra 2M b/d into a saturated market, it has also discounted current crude oil sales by about 20% from the last official prices leading up to the decision – a cut of US$8/barrel from a price of around US$45/barrel.
The move will be a boost for the tanker market, pushing the market into contango, with traders and refineries looking to stock up on the cheap crude oil while it is available. For those with oil already on the water, the Saudi Arabian move is a disaster, though, and refiners will be looking to renegotiate prices in line with the current market.
Saudi Arabia’s massive crude oil supply reserves and output means it can play this game almost indefinitely. However, there is one factor being overlooked – Iran.
Iran is reliant on higher crude oil prices to maintain its fragile economy with sales to non-aligned customers. If the current market persists, the only way Iran can influence the crude oil price is to squeeze supply at the choke point: the Strait of Hormuz.
Tanker operators, be wary.
This year sees the launch of the inaugural Tanker Shipping & Trade Conference, Americas on 29-30 April 2020 in Houston, Texas.