On April 20, the prices of US oil contracts for May delivery fell to their lowest level in history, crashing below $0 a barrel, in parallel with the drop in available storage spaces globally. This unprecedented predicament is due to the abundance of oil supply that global economies no longer need as a result of the almost complete closure of many airports, ports, factories and companies due to the Covid-19 pandemic affecting the world. Indeed, the repercussions of the pandemic have led to a decline in global oil demand to about a third.
The Covid-19 pandemic is not the only reason for the drop in oil prices, but it is perhaps the most significant cause now. Indeed, oil disputes are not a result of the moment, in light of the US’s eagerness to maintain the lead in oil producing countries, and this is why the US sought to prevent the market from crashing and adding pressure to sign the OPEC Plus agreement.
The OPEC Plus agreement is one of the new inputs that may present a partial exit out of the falling oil price crises, which OPEC countries, along with Russia, reached on April 10, which provides for reductions of 9.7 million barrels per day in May and June, with approximately 10% of daily production. Accordingly, Saudi Arabia and Russia will reduce production from 11 million barrels to 8.5 million barrels.
This report will assess the situation and examine the effects of the drop in oil prices due to Covid-19, and its impact on the major oil exporting countries, and the future of the OPEC Plus agreement.
Context of the oil dispute and the position of different parties
The oil price wars are renewed from time to time, due to major oil producing countries seeking to increase their market share, and increase the revenues that they derive from oil prices. In addition to the Corona pandemic and its repercussions, which are the most important causes of falling oil prices, the last agreement reached by OPEC countries with Russia before OPEC Plus, were the cause of reducing production in 2016. In 2014 an agreement was also reached to cut production when there was any decline in prices.
The US position
In 2018, America became the largest source of oil, and it still ranks first to date (13 million barrels per day). Shale oil is the first affected by any decline in oil prices, given the global cost of its extraction. When oil prices hit less than $20, the US shale oil companies were disrupted, incurring a large amount of debt in exchange for production, and therefore the price could not cover these companies’ expenses. Indeed, new gains cannot be made if the price reaches less than $35 a barrel, according to the British newspaper ‘Financial Times’.
This is why Washington seeks to prevent the increase in world production, and as a result of US pressure, the agreement was signed. In order to succeed, the US assumed Mexico’s share of the reduction, as Mexico rejected the proposal to reduce its production by 400,000 barrels per day, and agreed to reduce it by 100,000 barrels only. The US accepted to reduce its share to compensate for Mexico’s refusal, and a number of sources spoke of great efforts made by the US President to reach a solution to the crisis in order to protect the interests of US shale oil companies from collapse. This confirms the persistent US role in managing the global economy in pursuit of the largest percentage of interests to serve the US oil economy.
The Saudi position
Saudi Arabia sought, from an early date, to reach an agreement between OPEC and Russia to reduce production and maintain stability of the oil market, based on previous agreements with Russia. Russia believes that reducing production to less than 11 million barrels raises prices and the greater beneficiary from that is the US, which will double its production, especially since it is not part of the agreements to reduce production. For this, Russia feels that the decline in oil prices will lead to pressure on the US which has increased shale oil production.
Saudi Arabia was unable at the beginning of the crisis to reach a solution, which allowed all oil-producing countries to raise their production and crash the market, including Saudi Arabia, which announced that it would raise its production from 10 million barrels to 13 million barrels. This, along with the corresponding Russian position, caused the market to flood and the price to drop to an unprecedented level.
Saudi Arabia considers the OPEC Plus agreement a victory for its oil policy, and the Saudi newspaper “Al-Riyadh” considered the agreement, “a success for the Kingdom’s oil policy, but also a multi-level Saudi success”, praising King Salman’s role in consulting with US President Donald Trump and Russian President Vladimir Putin, “and overcoming all difficulties to return to the international consensus. This was the greatest impetus to make a breakthrough worthy of the countries that lead the world’s energy”.
The Russian position
Russia is suffering from the US sanctions imposed on companies contributing to the construction of the Russian gas pipeline, such as “Nord Stream 2”, which is one of the axes of the economic war between the US and Europe, and strengthens the Russian influence in Europe and its dependence on gas. Therefore, the us-Russian economic war is not a new thing.
Russia believes that the US is the first beneficiary of the production cut, and is not part of the last agreement and, therefore, is not covered by the recent decision to reduce. For that reason, Russia strongly prevented reaching an agreement on reducing production. In response to the previous Saudi announcement to raise production, Russian Energy Minister Alexander Novak said: “Moscow may boost production in the short term by 200,000 to 300,000 barrels per day, with the possibility of raising it to 500,000 in the future.”
The OPEC Plus agreement is considered an appropriate way out for Russia, which suffers from a portion of indirect investments and cannot afford the collapse of oil prices, as it has been suffering from the US-imposed sanctions for some time.
Effects of the oil dispute under Covid-19
The Coronavirus pandemic, which affects countries across the world, has had many impacts on all levels: economic, social and political; and the decline in global demand for oil has led to lower oil prices which has exacerbated the suffering and had a direct impact on oil countries. According to the World Economic Outlook report issued by the International Monetary Fund (IMF) on April 14, the global economy is experiencing the deepest recession since a century ago, with economies in the Middle East and Central Asia shrinking by an average of 3.1% this year. The report acknowledged the difficulty of setting accurate forecasts as the pandemic continues to evolve.
Its effect on the US economy
The US is considered to be the most country affected globally by the drop in oil prices. After the price of crude oil reached $63.27 a barrel in January at the beginning of this year, US crude oil fell to 71% of its value and decreased to $17.33 a barrel. This required the intervention of US diplomacy with OPEC countries to try and find a solution to reduce production. And with Saudi Arabia and Russia announcing joint agreements on oil production, the price of crude oil rose to $28.34 a barrel on April 3, and recorded a new 8% decline again on April 17, to reach its lowest level in 18 years at $18.27 a barrel.
On April 20, West Texas’ long-term crude oil contracts due for delivery in May, which expire on Tuesday, fell by more than 100% to -$37.63 a barrel. This happened for several reasons, chief among them is the sharp drop in global demand and the US storage approaching full, with traders seeking to get rid of their stocks. The price of a barrel of US oil in Asian trading jumped above zero on Tuesday morning, April 21, and the price is expected to improve later.
The US shale oil is the most affected by the decline in oil prices. The fact that oil prices reached less than $20 worries US oil companies, because they incurred large amount of debt as a result of drilling projects and production costs, and the inability of this price to cover the companies ’expenses. Rystad Energy, the Norwegian company specialised in energy consultancy, estimated that 140 oil producers in the US may file for bankruptcy if oil prices continue to reach $20 a barrel in 2020, which explains the threats directed by the US at the different members of this oil crisis.
Its effect on the Russian economy
The pandemic’s repercussions resulted in the exacerbation of the Russian suffering, as Russia’s Finance Minister, Anton Silyanov, said: “Russia’s budget revenue from oil and gas sales will be three trillion rubles ($39 billion) less than expected for this year due to lower crude oil prices.” This is the lowest level in four years, and several Russian airlines are on the verge of bankruptcy due to the consequences of the Coronavirus.
Its effects on Saudi Arabia and oil-dependent countries
The drop in crude oil prices to less than $25 a barrel of Brent oil has directly threatened countries that rely heavily on oil exports. Indeed, they need oil prices between $60 and $85, if not more, to balance their budget for 2020. Low oil prices lead to damage to the reserves of those countries, especially the GCC states.
In light of these repercussions, many countries have taken serious measures to reduce the impact of decreased oil prices, including the government of Saudi Arabia, which earlier approved a partial reduction in its budget in some items with less social and economic impact. The size of the partial reduction in those items has reached nearly 50 billion riyals, which represents less than 5% of the total expenditures approved in the budget for 2020. These measures that have been put in place may not amount to the expected deficit. Additionally, the decline has affected the financial balance policy launched by the government of Saudi Arabia; it exceeds the assumed pessimistic vision of $45 per barrel. These challenges will directly affect Vision 2030 as it will affect the budget for this year, where Saudi Arabia needs a price of $80 per barrel to control the deficit in the annual 2020 budget, according to the IMF report.
Dubai is the first country affected from the GCC countries, according to the report of the US newspaper ‘Bloomberg’ on April 11. The report stated that the general index of the Dubai Financial Market decreased by 26% since the collapse of global stocks at the beginning of March. Although Dubai depends on economic sectors other than oil, such as tourism, trade, etc. – these also have been greatly affected.
Iraq is the second largest producer in OPEC after Saudi Arabia, and for this the impact of low oil prices on it were significant. According to the International Energy Agency spokesperson, Fatih Birol, Iraq is the weakest link in this oil war, as its oil revenues constitute more than 90% of its revenues. This means that it will face enormous economic pressures as this will lead to a decrease in Iraq’s net income by 65% in 2020 compared to last year, causing a monthly deficit of $4 billion.
Future growth rates for oil countries after the agreement
Based on the aforementioned data, the decrease in oil prices that hit the global market drag the oil-producing countries, especially those that are mainly dependent on it, into a real crisis. With the continuation of the Corona pandemic, even the agreement to reduce production will contribute only to approximately 33% of the solution. This is because the decline in demand exceeded 30%, and the initial reduction prepared for 10%. With the pandemic looking to continue, it is expected that the decline in demand will increase and this will lead to an increase in the price decline, and the crisis may return to its beginning. It is difficult to know who will be the winner in the battle of the oil price war, especially between the three countries (Saudi Arabia, US and Russia), even though the cost of production in Saudi Arabia is lower than in the US and Russia, but the one that resists longest will be the winner, particularly with the continued repercussions of the Coronavirus pandemic and the inability of attaining 10% to resolve the crisis.
Russia needs approximately $50 a barrel to maintain its budget given the limited borrowing as a result of the sanctions imposed on it, while the US needs a price of more than $35 a barrel, yet the continued low demand and lower prices will clearly affect oil companies. However, MENA countries need prices to range between $60 and $85, and Nigeria needs the price of $144 dollars to achieve a balance of its budget for this year. Non-OPEC countries, such as Mexico and Kazakhstan, need an average of $49 dollars and $58.
In addition, according to the International Finance Institute, countries of the Middle East are expected to see a decline in growth rates for 2020, and these estimates indicate that the growth rate in Saudi Arabia will reach 0.7% for this year, in Kuwait 0.8%, and 0.6% in the UAE. The Iraqi economy is also expected to shrink by 0.3% and the Iranian by 8.4% this year. According to the institute, if average oil prices reach $40 a barrel for 2020, nine countries from the MENA oil-exporting countries may see a decline in profits of hydrocarbon products totalling $192 billion, with the erosion of monetary reserves and further external debt affecting the 2020 budgets of these countries.
The Corona pandemic continues to hit the world and its repercussions are still developing day by day. It may be difficult to determine its outcome, but in light of the current data, it continues to affect economic activity in general and the oil market in particular.
Although the OPEC Plus agreement is an input to stabilise oil prices, if it comes into effect from the beginning of next month, prices will not return to what they were before the pandemic. This recovery depends on the return of global stability after emerging from this recession caused by the pandemic. Furthermore, there is the possibility of renewed oil disputes, especially if US shale oil continues to be affected. Therefore, lowering the production to 10% does not provide a complete solution to the crisis.