The sharp drop in oil prices might bring relief as economies struggle to re-stabilise, but there are costs for some.

One of the most visible economic consequences of the COVID-19 pandemic has been an unprecedented drop in oil prices. At the outbreak of the disease in China, oil prices began to fall, but since the pandemic was declared, they plummeted. Sharply (Zeihan, 2020). So much so, that for a brief moment, West Texas Intermediate – a grade of crude oil used as a benchmark in oil pricing – hit negative prices. With billions of people staying home, restricted vehicle movement, and paralysed industries, estimates say the quarantines have caused a 29% drop in global demand. With production continuing, that means some 29 million excess barrels of oil were entering the market – daily. Producers were actually paying buyers to take their oil (IEA, 2020; Ramkumar, Wyatt and Eaton 2020).

‘Russia and Saudi Arabia, the world’s two largest oil producers, went into a price war last month, further driving prices into the ground’

To further complicate things, Russia and Saudi Arabia, the world’s two largest oil producers, went into a price war last month, further driving prices into the ground (Zeihan, 2020). Presently, however, both countries have signed a deal to cut production by a historic 9.7 million barrels a day. The biggest in history.

However, this unexpected event might leave behind a smaller supply market just as economic recovery begins in earnest. The problem is that not all producers have equal position in the market. Some, like the Gulf countries, have some of the cheapest high-quality oil in the world. Other countries like Canada, not only have to look for it beneath icy tundra, but also heavily process the sandy muck that is excavated before it is anything resembling marketable. Consequently, the price at which producers make a profit ranges from $20-$30 a barrel in the Gulf to well over $100 in Canada or Venezuela. Today, after prices surged, they ranged from $25 to $30 a barrel (Winck, 2020).

Global breakeven prices (considering only technical extraction costs) versus production. Source: Alliance Bernstein, October 2014:

“Producers from the Americas to Africa, who were already struggling to make profits before, will see all their investment dry up”

Should these OPEC+ countries stick to the above-mentioned agreement, it will still take months for markets to re-absorb the extra oil that was pumped into the system. Cheaper producers like Saudi Arabia or Russia can survive in this environment. The problem, however, lies with the rest. Producers from the Americas to Africa, who were already struggling to make profits before, will see all their investment dry up. As a result, oil rigs will have to close and supply will fall over the course of the year. Hence, by 2021, when the few producers that manage to survive this crisis are still standing, they will set the price.

I suspect it won’t be cheap.

By Cristobal Sapena

A Cov360 team member and contributor

Bibliography

Bloomberg. Oil Price War Ends With Historic OPEC+ Deal to Slash Output. 13 April 2020. https://www.bloomberg.com/news/articles/2020-04-12/oil-price-war-ends-with-historic-opec-deal-to-cut-production.

IEA, Oil Market Report – April 2020. https://www.iea.org/. April de 2020. https://www.iea.org/reports/oil-market-report-april-2020.

Ramkumar, Amrith, Tristan Wyatt, y Collin Eaton. «The Glut Drowning the Oil Market.» The Wall Street Journal. 7 de May de 2020. https://www.wsj.com/articles/the-glut-drowning-the-oil-market-11588843801.

Winck, Ben. “JPMORGAN: The struggling oil market finally stabilized, but recovery will take up to 3 months.” markets.businessinsider.com. 7 May 2020. https://markets.businessinsider.com/commodities/news/oil-price-market-stabilizing-recovery-take-months-coronavirus-demand-jpmorgan-2020-5-1029179103.

Zeihan, Peter. “Coronavirus: The Energy Guide.” zeihan.com. 3 April 2020. https://zeihan.com/coronavirus-the-energy-guide/.

Zeihan, Peter. “Oil: The Storm Before the Really Big Storm.” zeihan.com. 21 April 2020. https://zeihan.com/oil-the-storm-before-the-really-big-storm/.

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.