By Bhamy V Shenoy
Since the formation of OPEC, there have been four major global oil-price wars. In 1986, price fell below single digit; in 1997, when the Saudis were upset about Venezuela flooding the US market, price fell from $20 /barrel to $10; during 2014-2016, it fell as low as $26; and, the one we are in currently, with price falling close to $20/barrel.
Such price wars occurred in the US soon after oil was discovered there. It was only after the Texas Railroad came into existence that such price wars stopped. In the international area, until the formation of OPEC in 1960, it was the seven sisters—consisting of major oil companies like Exxon, Chevron, Shell, BP, etc—that controlled production and oil pricing.
A few years after OPEC came into existence, it started to control prices. However, when demand exceeded supply—because of disruptions, like in 1973 (first oil shock), and 1977-78 (second oil shock)—OPEC just followed higher oil prices.
The first three world oil price wars (WOPW) were initiated by Saudi Arabia. When other OPEC members did not follow quota discipline, and Saudi production fell to an uncomfortable level, the Saudis opened the tap to gain market share. When price fell to very low levels, other OPEC members agreed to limit their production quota.
In 2014, to increase their market share, Saudi Arabia started the third WOPW to compete with US shale oil producers. The country also wanted to stop the free-loading by non-OPEC members. This finally resulted in price dropping to $26/barrel.
To the surprise of the Saudis, and also that of other OPEC members, US shale oil production continued to increase. The Saudis expected that when oil price fell to $70/barrel, supposedly the breakeven price, US shale oil production will shut down. In the event, the US continued to increase production, even at much lower oil prices.
It is always acrisis that forces even competitors to cooperate to find a solution. In 2016, OPEC sought, and was able to gain support from other oil exporting countries, led by Russia, to form OPEC+. OPEC+ managed to stabilise the price of oil in the range of $50 to $70 per barrel—until, that is, the world faced a black swan event by way of the coronavirus outbreak.
Even as recently as February of this year, when the world started to get news of an outbreak in China, IEA, EIA, and OPEC expected world oil demand to increase by at least one million barrels per day (mmbd), or more. Even with such an increase, and the already agreed 1.7 mmbd production cut, the market was experiencing a surplus. On March 5, OPEC members agreed on another reduction of 1.5 mmbd, provided that Russia, too, agrees. However, to the surprise—and shock—of Saudi Arabia, Russia refused to go along with any production cut, and walked out of the meeting.
The market was not expecting such a dramatic development. Thus, the fourth WPOW started, along with the global economic meltdown—a direct result of coronavirus outbreak. Soon after the breakdown of the OPEC+ talks, price fell by 30%, and has, since then, been falling every day.
Russia has been claiming that it can increase production by 0.3-0.5 mmbd. Saudi Arabia has been threatening to produce an additional 2.5-3 mmbd, and other Gulf countries may add another one mmbd. Thus, the total world oil supply may increase by close to 4 mmbd. It will take some time for US shale production to come down as a result of the lower oil price. Even as supply was increasing, oil demand has been falling due to the coronavirus outbreak.
It looks like the impact of the SARS CoV-2 outbreak in China has flattened out, and the economy is slowly starting to come back to normalcy. However, in most other countries, it is a different story. With countries locking down, employees of major companies working from home, forced social distancing, and domestic and international travel curtailed, oil demand may fall as much as 5 mmbd during the next quarter. Thus, the world may face an oil surplus of 9 mmbd, making it difficult for OPEC to balance supply and demand. Never in the sixty-year history of OPEC has there has been such a dramatic increase in oil supply, or such a drastic decrease in its demand.
Under the current supply-demand imbalance, it is the marginal cost that will put a lower limit on the oil price. During the third WOPW, price fell as low as $26/barrel, perhaps the marginal cost at that time. Since the oil industry has been able to achieve large efficiency gains since then, price may fall to even lower levels—as low as $20/barrel—which will be a disaster to the oil industry.
This is good news for oil importing countries like India in the short term. However, when oil demand picks up again, prices may overshoot because of limited oil production capacity (even if US shale production picks up again), hurting oil importing countries—there is historical precedence for this.
Another consequence of lower oil prices will be slowdown in energy transition. At the current oil price, renewables will hold less attraction. Perhaps, Saudi Arabia, and other OPEC members whose budgets will be under severe stress may draw some comfort from this unintended development.
As for Russia, there are theories to explain the unexpected non-cooperation with OPEC, especially given Russian president Vladimir Putin’s closeness to Crown Prince Mohammad bin Salman. One theory is that Russia wanted to ‘punish’ the US for its sanction against the Nord Stream-2 gas pipeline by forcing US shale companies into bankruptcy. Another theory claims that by reducing Saudi Arabia’s cash-flow, Russia wanted to prevent the development of Jafurah shale gas in Saudi Arabia, which would otherwise compete with their gas export exports.
It is possible that Russia committed a gigantic blunder—it might not have expected oil to fall below $40/barrel. Since Russia’s budget breakeven price was $42/barrel, it was hoping to manage with lower oil price. In the event, the country’s strategy has failed miserably.
As the fourth global oil price war wreaks havoc in the energy sector, along with a potential global economic meltdown, there are no clear winners. More than likely, all are losers—certainly, in the medium term, with energy transition delayed.
The writer is Former manager, Conoco, and former board member of the national oil company of Georgia. Views are personal
