COVID-19: Price war between Saudi Arabia and Russia leads to fastest fall in crude price since 1991 (Update 2)

17:37 PM | March 9, 2020 | Natasha Alperowicz

A row between Saudi Arabia and Russia, two of the world’s biggest oil producers, has sparked a price war and sent the price of crude oil tumbling 30% over the weekend, its fastest fall for decades. At the time of writing, Brent crude stood at $37.33/barrel, down 46% from its high at the beginning of January this year. The drop comes at a time when the global economy, and hence actual and projected demand for oil, is already suffering from the effects of the coronavirus disease 2019 (COVID-19). IHS Markit warns that the demand shock amounts to 4.5 million b/d below pre-virus forecasts. Meanwhile, the International Energy Agency predicted on Monday a full-year reduction in demand of 90,000 b/d in 2020, the first annual fall since 2009. 

Saudi Aramco shares, reacting to the oil price crash, dropped below their IPO level of 32 Saudi riyals ($8.51) per share for the first time over the weekend, falling more than 14% from the Thursday close to SR28.35 on Monday. They have since rebounded to SR31.15. The price was as high as SR35 on 9 January. The decline in the Aramco share price is a blow to the prestige of Saudi Crown Prince Mohammed bin Salman and the Saudi government, who hailed the $29-billion Aramco IPO at the end of last year as a major step in their efforts to diversify the country's energy-dependent economy. It also throws into doubt Saudi Arabia's ability to sell more shares in Aramco in the future if needed to shore up its budget. If it comes as any comfort to the Saudis, Aramco shares, despite the share price fall, have greatly outperformed their peers since early January. Shell shares have fallen 41% since 10 January, and 17% over the weekend; ExxonMobil has fallen 37% since 10 January and 8% over the weekend. 

The collapse in the oil price follows a failed attempt by OPEC and the so-called OPEC+ alliance, headed by Russia, to support the market with coordinated cuts in production. Last week Russia rejected a Saudi-led OPEC request for a further cut of 1.5 million b/d, making 3.6 million b/d in total, causing the partnership to collapse. Saudi Arabia slashed its export prices for oil and both it and Russia threatened to increase production and flood the market with their crude when the current agreement ends on 1 April. Until Friday, Saudi Arabia and Russia had maintained an uneasy alliance since 2016, both agreeing to keep a lid on their output. Now, Aramco plans to provide customers with 12.3 million b/d of crude in April, an increase of 300,00 b/d over its maximum sustained capacity, the company said on Tuesday. 

Despite a slight bounce on Monday and today, experts warn that the oil price could go even lower. "I saw the first shock and the first collapse and this is worse," said Qatar's former oil minister and president of OPEC Abdullah bin Hamad al-Attiyah, in an interview with S&P Global Platts. "My expectation is for oil to fall below $20 per barrel." Goldman Sachs lowered its second and third quarter forecast for Brent crude to $30/b, and also warned that the price could test $20/b in coming weeks.  

The collapse in the oil price is likely to lead to delays in energy and chemicals investment in both the developed and developing world as investment budgets at state and private-sector integrated energy and petrochemical companies come under pressure, adding to existing COVID-19-related uncertainties over demand. The situation could become particularly acute in cash-strapped OPEC countries, such as Iran, Iraq, Algeria, Angola, Nigeria and Venezuela, and oil-dependent non-OPEC countries. Even Saudi Arabia is said to need an oil price of around $80/b to balance the budget and support its cradle-to-grave welfare system, which helps keep a lid on potential political unrest. 

Paradoxically, many of the most populous and poorest oil-dependent countries will have a greater incentive to keep pumping as fast as possible over the long term if the price war lasts for more than a few months, in order to maximize whatever revenues they can get. Some analysts say that the threat of these countries’ oil reserves becoming stranded assets in 1520 years’ time could lead to a radical change in their attitude toward production controls, which could threaten the basis of the OPEC cartel.

In the short term, the oil price collapse will trigger a sharp decline in the prices across the board of petrochemicals and other energy-related products, accentuating the trend in recent months. Regardless of potential long-term benefits to the competitiveness of oil-derived products such as plastics and synthetic fibers, it is also likely to lead to a short-term drop in chemical demand as companies throughout the chain destock in anticipation of lower prices to come. At the lighter end of the industry, the disruption to global supply chains, notably from China and India, from the COVID-19 virus will give an added impetus to the trend toward reshoring of fine chemicals production.  

There will also be a halt to planned capital-raising and refinancing operations, including IPOs, of energy-related companies. Doubts were already being cast on the timetable for the planned flotation of Wintershall Dea by BASF and LetterOne, due in the second half of 2020, in view of COVID-19.The oil price crash is a further setback to those plans. Also under threat of delay is Aramco's projected $15 billion acquisition of a 20% stake in Reliance Industries' (RIL) refining and petrochemical operations. "We estimate the sharp decline in RIL's share price is implying that the value of the refining and chemical segment has halved versus the start of the year," Goldman Sachs said, in a report dated 9 March. RIL already revealed in January that the deal would miss the 31 March deadline. 

Russia's refusal to join OPEC in cutting oil production was officially stated to be because it wanted to see the full impact of COVID-19 on demand before acting. The Kremlin is confident that it can withstand a prolonged price war as its economy is more diversified than Saudi Arabia's and an oil price of $40-42/b is sufficient to balance the budget. It is clear, however, that Russia also has the US shale industry in its sights. It believes that cutting oil output would only hand a lifeline to a sector whose growth has turned the US into the world's largest oil producer, gaining customers at Russia's expense. US sanctions on Russian energy companies, including those that target a subsidiary of state-backed Rosneft for its trading in Venezuelan crude, and attempts to halt the Nord Stream 2 gas pipeline to Germany, have also infuriated Moscow. 

US shale operators generally need oil prices of $40-50/b to be economically viable, though some producers claim a breakeven price as low as $29/b. Analysts expect a sharp decline in drilling activity in the near future if the price stays at current levels. In addition, North American oil and gas companies have more than $200 billion in debt maturing over the next four years, with $40 billion due this year. Refinancing these loans will be next to impossible in the current economic climate and widespread bankruptcies could result. Goldman Sachs sees West Texas Intermediate crude, the most important benchmark for US drillers, falling to $29/b and 28/b, respectively, in the second and third quarters.