Big Egos, Poker Faces, and Deep Pockets Meet to Address Oil Glut

President Putin

President Vladimir Putin of Russia has a poker face and knows how to use it. A real-life display of his diplomacy-on-ice takes place today as OPEC oil and energy ministers meet online to discuss ways to avoid a further collapse of oil prices. Non-member Russia has been invited to join the virtual get-together and the United States may also make an informal appearance in what market watchers dubbed the advent of OPEC++. The expanded roster reflects the sense of urgency within and without the organisation.

Founded in 1960 to bundle the power of oil producing and exporting countries, OPEC has of late become a somewhat marginalised forum of nations unable to even agree to disagree. Member states mostly ignore production targets as they seek to capture market share and drive competitors out of business.

Russia has been particularly successful at exploiting divisions within OPEC as it wrestles with Saudi Arabia for leadership of the sector. Moscow also seeks ways to exact revenge on the United States for the tightening of sanctions over its meddling in the Ukraine and other supposed misadventures such as the Nord Stream 2 pipeline. One way of getting even is to drive US producers of expensive shale oil out of business by aggressively lowering prices.

In early March, Russia abruptly terminated an agreement reached with Saudi Arabia in 2016 and aimed at limiting production volumes in order to support crude prices. The deal was scrapped after Russian oil minister Aleksandr Novak angrily refused to honour a renewed Saudi request for deeper production cuts. A barrage of recriminations followed with the Russian minister vowing to flood the market and the Saudis promising to do likewise.

However, it has since transpired that whilst Riyadh took Mr Novak at his word and duly ramped up daily oil production to as much as 19 million barrels – more than double the volume pumped in normal times – the Russians kept their production levels largely unchanged, refusing to engage in a losing proposition.

The oil spat coincided with the spread of the corona virus that ground the global economy to a halt. Demand for crude oil dropped by at least 25 percent as airlines stopped flying, cars sat on driveways, power plants cut output, and winter failed to bite. This perfect storm drove crude prices to lows not seen in almost 20 years and saw the largest quarterly percentage decline on record. By late march, West Texas Intermediate scraped the $20-a-barrel level with some lesser crudes trading at $10 or less a barrel.

Thus, US President Donald Trump got what he wished for: cheap oil. Not usually one to think more than a few baby steps ahead, the Trump Administration now reluctantly admits that slightly less cheap oil may be not so bad after all. US producers of shale oil are dropping like flies. In order to cover their cost of production, they need a crude price of at least $42 a barrel. The Department of Energy noted that daily production volumes have already dwindled by about 300,000 barrels in March. US oil output may slump by as much as 2 million barrels a day by year’s end. In an attempt to stabilise the global energy market, President Trump called on his Russian counterpart to cooperate towards this goal. President Putin of course agreed on the importance of calming the market and promised, rather ambiguously, that Russia would do its part.

As the US reluctantly prepares to coordinate with OPEC, Russian Oil Minister Novak warned that a ‘natural decline’ in production will not count towards any cuts to be agreed upon. Mr Novak is aware that the US government may actually lack the power to impose ceilings on its small shale oil and natural gas producers. He also realises that these companies are very nimble and can adjust their output quickly to changing market conditions. Each time the Saudis or Russians think that pesky shale oil has been put out of business, the sector bounces back to spoil OPEC+ targets and plans.

After OPEC++ meets today, the oil and energy ministers of the G20 get together on Friday to consider the outcome and find additional ways to adjust production to the reduced demand. In fact, the world is quickly running out of places to store excess oil. Tank farms are just days away from reaching capacity whilst entire fleets of old tankers are saved from the breakers yard and rushed into service as floating storage facilities.

Land-locked oil producing countries are hardest hit. Some have seen well-head prices for crude dip into negative territory as hauliers have nowhere to unload their cargoes. In Canada, new lows were recorded in the last week of March. With pipelines saturated and local tank farms topped up, West Canada Select – more than two thousand kilometres distant from the closest tanker storage facility – was being traded at $4.18 a barrel.

Analysts at Goldman Sachs estimate global storage capacity at around one billion barrels and caution that maximum capacity may be reached in weeks rather than months. In a report to investors released earlier this week, the market watchers of the US investment bank point out that the supply overhang from the global lockdown is so big that storage capacity will be exhausted soon even if OPEC and other producers manage to restrict output.

Though there is a common desire, and urgent need, to close the tap – if only to limit the financial damage suffered by Russia, Saudi Arabia, and other major producers – it is by no means certain that Moscow will sign on to any initiative supported by either the Americans or the Saudis. The forces ruling the global energy market include large egos and hurt feelings. The Saudis, determined to rule supreme in the global energy market, seem unwilling to take on the heaviest burden as they have often done in the past by scaling back production much more than others. Though the Saudi government may in the end grudgingly acquiesce to US demands for considerable cutbacks, Russia is unlikely to respond to such strong-arm tactics.

What oil producing country cannot do may ultimately be accomplished by the market. ExxonMobil CEO Darren Woods stated the obvious when he mentioned the unstoppable force of business economics: “When there is no demand for a product, you eventually stop making it.”

Though Saudi Arabia is able to pump oil profitably at a well-head price of less than $10 a barrel, the International Monetary Fund calculated that the country needs a price of at least $80 in order balance its budget. The fund fears the deficit could balloon to 40 percent of GDP should the oil price remain at or around its current level.

At Energy Intelligence, Director for Market Research Abhi Rajendran does not expect that to happen and predicts a firm rebound in 2021 and incremental price increases thereafter. He sees a return to $80-a-barrel oil within three years and expects Saudi Arabia to further increase its market share. Mr Rajendran notes that the Saudi government again sticks to the traditional formula of ‘short term pain for long term gain’ which always worked in the past and is likely to do so again.

In a tug of war with the Saudis, a poker face undoubtedly helps but is still trumped by deep pockets and even deeper wells.