Time to Call Off the Oil War

When we wrote our (March 3) commentary in advance of the ill-fated meeting of the Organization of Petroleum Exporting Countries-plus (OPEC+) Alliance, the signs of an impending problem were already clear. The projected economic implications of COVID-19 were trending more negative, OPEC’s February output was already the lowest in a decade, and Russia was balking at further cuts and reportedly disinclined to put a floor under prices so others (e.g., U.S. tight oil producers) could continue to capture market share. For its part, Saudi Arabia remained intent on continuing its substantial reductions only to the extent that others would join. Our commentary concluded with the statement that regardless of the action OPEC took, it was unlikely to be adequate enough to produce the group’s desired outcome of stabilizing the market and substantially increasing prices.

Nonetheless, we assumed that at the end of the day, the Alliance would inevitably reach at least a short-term agreement if for no other reason than the alternative of failing to do so would simply prove too damaging for both markets and the viability of the Alliance going forward. So much for logic . . . though the damage prediction is proving far more disastrous than previously imagined.

Setting aside for the moment (detailed postmortems on the March 5 session will inevitably materialize in the months ahead) how a series of questionable assessments, miscalculations, and overreaching may have doomed the session before it began, the fact of the matter is that the aggressive brinkmanship that has followed has unequivocally made matters immeasurably worse.

Prior to the OPEC ministerial meeting, the organization’s Joint Technical Committee had assessed the state of the global economy and the oil market and concluded that an additional and substantial cut in OPEC supply was needed to stem the growth in oil supply and stocks, particularly in light of the projected adverse demand impacts from the coronavirus pandemic. Regardless of individual member perspectives, there was no disagreement that given ongoing health and economic concerns, there was simply too much supply and not enough demand.

Yet following the conclusion of the ill-fated OPEC+ session, both Saudi Arabia and Russia quickly announced plans to increase supplies to the market, with Saudi Arabia upping the ante with plans for cutting prices, expanding capacity, increasing exports, and releasing global stocks. The announcements immediately triggered a number of analytical assessments suggesting which countries were best suited to survive such a low-price competition.

In the intervening weeks, global oil prices have continued to plunge. At this writing, Brent and Russian/Urals barrels are trading in the mid-$20 per barrel range; U.S. West Texas Intermediate is down an additional $4 at $22 per barrel (an 18-year low).The market continues to experience high volatility as distressed barrels seek buyers. And while none of this is sustainable long term, we have likely not yet hit bottom.

In the short term, crude buyers, to the extent they have a place to put the extra barrels, are deriving some benefit from being able to purchase discounted supplies. But as available storage becomes tighter, costs for stockpiling oil, including floating storage (on board tankers) are eating into the discounts. Tanker rates have soared, causing some buyers to actually turn back substantial cargoes.

As the coronavirus spreads and communities shutter in place, huge swaths of the global economy (e.g., airlines, land transport, and water transport) have and are dramatically cutting oil consumption. Yet supply continues to grow. The oversupply that can’t be consumed is causing inventories to surge to unprecedented levels.

Less than two weeks from now, when the current OPEC+ agreement expires, yet another wave of additional supply is projected to hit the market, putting further downward pressure on prices and straining companies, financial institutions, communities, and nations, including OPEC and Russia.

Even allowing for the initial rationale that downward price pressure would eventually eliminate at least some of the current overproduction, especially from non-Alliance members, that logic is simply no longer defensible. At prices below $20 per barrel, little production is economically sustainable. And with COVID-19 and the attendant economic fallout, lower prices are unlikely to stimulate significant new demand anytime soon. Global economic activity is at a standstill and will be hard pressed to register positive growth for the year. The United States appears to have entered recession territory this month, and even an eventual recovery seems more likely poised to emerge as a “U” or an intermittent “W” rather than a resurgent “V.” Maybe worse yet, price considerations are incentivizing moving additional barrels into storage—recreating the enormous supply overhang the OPEC Alliance was created to dispatch in the first place.

And while it is true that sustained low prices will reduce the growth in U.S. oil production (a key Russian objective), bankruptcies and consolidation that transfer assets for cents on the dollar may ultimately allow purchasers to emerge even more competitive with a slate of higher quality assets.

COVID-19 continues to plague the world, and no country is completely immune from its spread. Saudi Arabia has reportedly suspended private sector operations in non-critical sectors (health and food services are currently exempt) and has pared back its own spending plans to adjust for expected revenue losses. For many governments reliant on oil export revenues, increasing volumes will not remotely compensate for severely declining prices. To the extent health and economic distress strain the capacity of even those nations with substantial cash reserves, the potential for protests and civil unrest cannot be discounted. Many OPEC member nations, including Iran, Iraq, Libya, Nigeria, Algeria, etc. are already feeling the strain. And countries responsible for inflicting damage on others often find few supporters when they themselves require outside assistance.

Further, to the extent that countries use the combination of this price war and COVID-19 to further attempt to insulate themselves from global trade and foreign investment, we may all be the worse for the change. A decided lack of needed foreign investment could be particularly damaging for Crown Prince Mohammed bin Salman’s ambitious reform and economic expansion agenda.

Reducing energy prices in times of economic strife is welcome news to consumers everywhere, but flooding an oversupplied market to punish competitors is only exacerbating the already dangerous economic conditions the COVID-19 pandemic triggered. Whatever rationale or perspectives that were used to justify the March 5 decisions have most certainly been overcome by a decided change in circumstances.

In times like these, anxious populations look to thoughtful leaders to constructively advance policies that seek to promote the general good rather than parochial interests. The oil market is not static and competing interests will constantly look for ways to subvert or counter adverse actions and impacts—often making matters worse. Leaders in Saudi Arabia, Russia, and elsewhere have a limited window in the coming days to rethink the wisdom of earlier decisions to flood the market with discounted crude. In the face of rapidly changing global circumstances, acting to promote stability in oil markets would provide welcome relief to an increasingly uncertain world. It’s an opportunity that shouldn’t be ignored.

Frank Verrastro is a senior vice president and trustee fellow with the Energy and National Security Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Albert Helmig and Larry Goldstein are non-resident senior associates with the CSIS Energy and National Security Program.

Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

© 2020 by the Center for Strategic and International Studies. All rights reserved.

Frank A. Verrastro
Senior Adviser (Non-resident), Energy Security and Climate Change Program
Larry Goldstein
Senior Associate (Non-resident), Energy Security and Climate Change Program
Albert Helmig
Senior Associate (Non-resident), Energy Security and Climate Change Program