Understanding the Impact of the Crude Oil Price War on the Middle East

Understanding the Impact of the Crude Oil Price War on the Middle East

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Here is closer look at the ripple effects of plunging oil prices and a weak demand for the commodity, as well as predictions on how the industry will cope in the near- to long-term

The Crude Oil markets have suffered from the 2X shock of the viral pandemic and politics, and has entered a frame of a relentlessly swelling surplus with storage being filled to its brim globally.

Crude Oil demand is set to contract this year, just as the leading petro-nations Saudi Arabia and Russia locked horns in raising supplies following the U-turn in the OPEC policy deal.

The widespread lockdowns across the major Western world economies is pushing the global economy into recession.

Crude Oil demand is set to decline as mandated or self-imposed quarantine measures owing to the outbreak of Covid-19 that 1st brought air travel to a standstill and have now temporarily frozen the overall economy continue. An estimated 10% of demand, or more than 10-M BPD, has been lost over the past several weeks.

Both the unprecedented pandemic-induced downturn and the U-turn in policy create an environment of elevated uncertainty. With Crude Oil policy absent, it is up to the market to bring supply and demand back into balance.

There is also increased speculation that The Trump Administration will join the petro-nations to re-introduce oil policy.

An agreement of some sort of economic stimulus with the US as the leader could help kick start policy discussions, prevent a bankruptcy scenario for the Shale Oil business and the risk of overall economic impact caused by excess supply.

Lifting sanctions on Russia or mandating output chokes to Texan shale producers might be convincing cards on the table.

The likelihood of finding an exit from the policy stalemate should not be underestimated.

The U-turn in policy already shattered the petro-nations reputation as a stabilizing force during turmoil, and another change of strategy would thus add little additional harm.

This stark price decline forces producers to throttle output and stimulate demand, setting the basis for a rebalancing, a process which will slow storage increases by early Y 2021.

All of the Crude Oil market actors will suffer from low prices, but for different reasons.

With prices below 30 per barrel, some parts of production can no longer cover their costs. In the near term, the focus is on US shale, not least because the fast drilling and completion means, that prices are compared to total costs rather than only operational costs, and that decisions not to drill come faster and have a more profound impact.

Interestingly, today’s turmoil likely accelerates productivity gains and structurally lowers shale’s cost base, turning this industry only more competitive in the longer term.

But, the industry will survive but some companies are set to disappear. ‘Big Oil’ has built a presence in the shale basins that is too competitive globally. The washout will likely be less drastic than in Y 2015 because the fall height is lower and the starting point is not super cycle exuberance.

In the longer term

The petro-nations will suffer because their economies and governments require high prices. Their respective Sovereign Wealth Funds can plug budget holes temporarily, for less than 5 yrs. The global downturn calls for more spending and thus aggravates the budget holes opened by Crude’s price decline thereby drying up of petro-Dollar revenues.

For the long-term perspective on the petro market, 2 Key topics come into focus.

Currently, 2 Key suppliers Venezuela and Iran, are out of the market.

Historically such supply disruptions never lasted long and supplies came back within years, for different reasons.

The Mexican energy reform, Venezuela rising from the ashes and Iran shedding sanctions could result in surplus supplies by Y 2025, putting more pressure on prices.

It is important to understand that petro-dollars are their economies’ lifeline and thus there are powerful incentives to bring Crude Oil back to the market.

Already before the sell-off, some companies’ access to capital tightened as investors and banks scrutinize demand growth under the concern of climate change.

Today, investments come to stand still and possibly set the basis for future undersupply and consequent Crude Oil price bounces. However, with the fast market share gains globally of EVs (electric cars) and automakers swiftly expand their offering, demand growth is set to slow beyond Y 2025 and reverse after Y 2030.

The Big Q for this market is what declines faster: supply or demand?

Just as witnessed for coal over the past 3 years, which already is a structurally declining market, there might be occasional price bounces upwards. The Crude Oil industry has been adjusting for the energy transition already for years by investing into Nat Gas or by paying out large parts of the cash flow to investors.

Based on the elevated coronavirus pandemic and politics induced uncertainty, Crude Oil prices are likely to continue to swing wildly near term, yet we see more upside than downside from the levels below 25/bbl and see oil prices on a recovery beyond 30/bbl by mid-year.

The mood looks as Bearish as it can get with hedge fund futures positions heavily tilted to the Short side. Even in historic terms, the current price slump is exceptional, but comparable sell-offs usually included a subsequent rebound from oversold marks.

Stay tuned…

Editor’s Note: Norbert Ruecker is the Head of economics and next generation research at Bank Julius Baer.

By Norbert Ruecker

Paul Ebeling, Editor

Have a healthy week, stay home!

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