ORIGINALLY PUBLISHED IN THE FINANCIAL TIMES.
The US and other producers are more co-dependent than recent years suggest.
For a brief moment following this month’s historic deal by oil producers to cut supply, the winners seemed clear. But the collapse in prices since — including this week’s historic crash below zero in US crude futures — has left market watchers asking who will be hardest hit as coronavirus obliterates demand.
US president Donald Trump was an apparent victor from the April 12 deal. He emerged from a frenetic round of telephone diplomacy with the Opec+ group of producers to get a 9.7m barrel-a-day production cut across the finish line, effectively ending the price war between Saudi Arabia and Russia. The ardent Opec foe became the champion of collective action in defence of America’s energy sector. Now, with WTI prices in the doldrums, he is once again being called on to save US shale producers and the assertive foreign policy that they enabled — at a moment when tensions with Iran are running high due to maritime skirmishes in the Gulf.
Brent, the international benchmark, is faring only marginally better than its US counterpart, leaving sovereign oil producers and their host governments facing a ruinous economic outlook. Opec+ ministers are working to formulate a response to shore up prices as investors question whether there is anything left in the policy toolkit to break oil’s fall, or whether economics will force the necessary production adjustments to bring the market back into balance.
No one will thrive in the current price environment. It is simply a matter of who will be best placed to survive the oil market’s annus horribilis and what lessons can be learnt for future crises.
While the explosive growth in US shale production allowed the White House to take a tougher line with foreign adversaries and to downgrade the importance of certain regions, the idea of energy independence was somewhat illusory.
The more than doubling of US output in the past decade helped shield consumers from having to pay a higher price at the pump while the country withdrew from the Iran nuclear agreement in 2018 — taking more than 2m b/d of Iranian exports off the market — before imposing crippling sanctions on the Venezuelan national oil company PDVSA the following year. American energy abundance also prevented an explosive rise in prices after last September’s attack on Saudi Arabia’s Abqaiq and Khurais facilities.
And yet it was not the case that the US no longer needed Middle East oil. Mr Trump worked the phones in 2018 to get Saudi Arabia to offset the Iranian export losses. The kingdom acquiesced, increasing its output by at least 1m b/d. In doing so, Mr Trump was following in the long tradition of American presidents calling on the Saudi leadership for more barrels to keep prices stable.
Perhaps less appreciated was the critical economic assistance that the sovereign producers were giving to their American shale counterparts. It was only after the Opec meeting last month ended in failure and the sovereign producers opted for an every-man-for-himself strategy that this codependent relationship became clear.
The fact that Mr Trump had to help repair the fractured Opec+ union and to get the group’s biggest production cut done shows that, in some sense, the US and other producers were always in it together.
One could certainly argue that the agreement earlier this month came too late to address the Covid-19 demand crisis, especially as the cuts will not start to take effect until next month. However, turning off the oil tap in the middle of the greatest demand crash in history was still a necessary step.
For oil-driven states this price crash demonstrates the need to redouble the diversification drive to prepare their economies for the coming energy transition. The current oil price is well below the fiscal break-even of such states. Opec producers and Russia, RBC estimates, have a collective break-even price of $90 a barrel to meet their spending commitments for 2020. Saudi Arabia’s finance minister this week announced that the kingdom could need to borrow about $26bn this year and draw down $32bn from its reserves to finance its deficit.
The more cash-strapped countries are now lining up to tap emergency IMF lending facilities and will brace themselves for more public protests as they struggle to pay civil servants and fund essential services. Three oil-producing nations — Iraq, Algeria and Sudan — saw their governments fall in 2019 in the face of popular protests over poor governance and a lack of economic opportunity.
If the oil-producing countries fail to make progress on reform and volatile prices continue to put pressure on government finances, this could be the shape of the future.
