Global oil market still reeling from price war and virus downturn

Have the end times finally come for oil? Of course, the industry is no stranger to the endless cycles of boom and bust, repeated decade after decade with jobs created in the good times and then chopped away swiftly in the bad.

This time may be different, say industry insiders. For many oil producers, coronavirus may represent an extinction event. Across the world, entire countries depend on oil to stay alive: Kuwait, Libya, and Saudi Arabia all rely on the black stuff for more than 50pc of their GDP.

After decades of decline, the US has rebuilt its own oil industry in recent years, as the shale boom transformed the country into the world’s top producer, ahead of the other two oil superpowers: Saudi Arabia and Russia.

In the UK, two of the most important listed companies on the FTSE 100 are oil giants BP and Shell. Yet all of these now face their greatest threat.

Around three billion people globally remain under some sort of lockdown, with the kind of economic activity that usually devours oil at a complete standstill. Airplanes, cars, factories, office blocks, and huge cargo ships have all sat idle for months.

Now, as prices and demand start to gradually recover, what will be the long-term impact on the industry?

The quieter, scaled-back lives that we will be forced to lead until a solution to Covid-19 is found is a hammer blow for oil producers.

But oil demand will not disappear altogether any time soon.

Who will emerge as the winners and losers from this brutal downturn? Across the US, the once-booming rigs that fuelled the shale revolution – which relies on relatively high crude prices to be profitable – have fallen silent.

Crushed by low oil prices, the heavily-indebted US oil industry is fighting to survive. As the US oil benchmark crashed past one cent a barrel, the sector looked all but doomed. At one brief stage prices for some grades of US crude turned negative, as traders were paying people to offload oil.

Enter Donald Trump, who swiftly vowed to take action to protect America’s shale industry from bankruptcy. He wrote that he had “instructed the secretary of energy and secretary of the treasury to formulate a plan which will make funds available” to US producers in a bid to save thousands of jobs.

Since then, US oil prices have rebounded, climbing back up to just over $30 (£25). But the industry is nowhere near being out of the woods, and analysts say that oil is unlikely to climb much higher.

Prices have been in freefall since Saudi Arabia and Russia launched an oil price war earlier this year, pumping out millions of barrels of oil at the very moment coronavirus caused demand to collapse.

It was a toxic combination that unleashed carnage on the market – and producers are still counting the cost. For years, Opec and non-Opec countries had maintained an uneasy truce, precariously held together by Russia and Saudi Arabia, the two central banks of the oil industry.

But on March 7, as the world stared into the abyss of Covid-19, that status quo was shattered.

Oil out war

Resentment towards the deal had been building in Russia. A central paradox of the agreement to cut oil is that there has always been one glaringly absent producer: the US.

Each time Russia and Saudi Arabia trimmed their production to lift the price of oil, it made more American shale producers financially viable, who would then in turn push more oil out onto the market. Rinse and repeat.

As coronavirus wrecked demand, however, Moscow realised that making deeper cuts would only be a gift to America’s energy industry. By pulling out, Russia would ensure that oil prices dropped precipitously, inflicting terrible pain on the US producers.

Moscow was set on tanking the US energy industry. “The Kremlin decided to sacrifice OPEC+ to stop US shale producers and punish the US,” says Alexander Dynkin, president of the Institute of World Economy and International Relations in Moscow, a state-run think tank.

The following day, Saudi Arabia retaliated by unleashing the full force of its titanic energy industry on the world.

It announced it would cut export prices by 10pc, signalling to the world that the old days were over: the taps had been turned on, and Riyadh was willing to sell oceans of cheap oil to whomever wanted it.

Russia responded, pledging to flood the market with cheap oil of its own.

The effect was swift and terrible: crude suffered its worst one-day drop in 30 years, and stock markets crashed.

The FTSE 100 closed down 7.7pc, suffering its worst drop since the financial crisis.

But ultimately, Russia’s risky geopolitical gambits, Saudi Arabia’s attempts to flood the market with oil, and the machinations of Opec, faded as the black hole of coronavirus steadily continued to expand, swallowing everything.

As March dragged on and more countries went in to complete lockdown to curb the spread of the virus, the destruction of demand became so severe that the price war became untenable.

Rapprochement

Just over a month after the price war began, it was over again.

On April 9, the world’s leading oil nations agreed once again to slash their output in a desperate effort to save the market from collapse.

Led by Russia and Saudi Arabia, the group of 23 countries pledged to cut production by at least 10 million barrels a day – a staggering increase on the amount suggested at the beginning of March. Saudi Arabia had been coerced into making a deal by US President Donald Trump, who threatened to cut military aid to the kingdom.

Russia, in turn, was brought to heel by the catastrophic impact of coronavirus on the global economy. Either way, the damage was done.

“It’ll likely take three years to work off excess stocks – maybe longer,” says Jamie Webster, an energy analyst at Boston Consulting Group. “Higher prices are very far down the track, and it is possible we are not actually going to move back to those prices, ever.”

For now demand will remain deeply depressed due to coronavirus, and supply will continue to far outweigh demand. To make matters worse, storage space for excess oil is almost full.

“The last gasp to balance this market is to shut-in production,” he adds. “This looks like where the market is going.”

Nuclear option

To shut-in production, or to stop wells from pumping, will be devastating and will result in huge job losses and a raft of bankruptcies, experts say.

“This creates a particularly stark challenge for the US,” says Reed Blakemore of the Atlantic Council Global Energy Center, “where a prolonged low-price environment has already introduced considerable stress on small cap producers.”

Now the shale industry is bracing for a crisis. Most companies in the industry, especially those laden with debt, are not economically viable when the price falls below $50 (£41). It is at $22 (£18) a barrel.

Distressed debt in the North American energy sector has increased to $190bn (£156bn), growing by more than $11bn (£9bn) in the last week alone. The industry faces $86bn (£70bn) in debt that comes due in the next four years, according to Moody’s.

The largest US producers were hit with a combined loss of $26bn (£21bn)in the first quarter, forcing more than $38bn (£31bn) in write-offs, according to Rystad Energy.

But the tripartite conflict and the subsequent downturn has not just devastated America’s oil industry. Saudi Arabia, the de facto leader of Opec, has seen its economy smashed and is battling profound fiscal challenges and the urgent need to reform.

Dreams of mega-projects such as Neom – a huge high-tech city on the coast of the Red Sea – now lie in tatters. And Vision 2030 – the grand dream to modernise the economy and wean Saudi off its dependency on oil – looks all but dead.

“I think Vision 2030 is more or less over,” says Michael Stephens, a Middle East analyst at the Royal United Services Institute in London. “It’s finished.”

The Kingdom, he said, was facing “the hardest time it’s been through, certainly the most difficult period of Mohammed bin Salman’s tenure”.

Last week, Saudi Arabia introduced a raft of tough austerity measures in response to the economic devastation wrought by Covid-19. The government said it would effectively triple the country’s VAT on goods and services overnight to 15pc, while gutting benefits programmes for state workers and placing other benefits paid to Saudi nationals under review.

“We are facing a crisis the world has never seen the likes of in modern history,” Mohammed al-Jadaan, the country’s finance minister, said. He noted that, as tough as the country’s new austerity measures are, they were also “necessary and beneficial to maintain comprehensive financial and economic stability”.

Russian roulette

Russia, too, has been seriously wounded by the industry’s collapse over the past two months.

Oil producers in the Urals, Russia’s hydrocarbon heartland, saw their oil delivered sell for just $8.48 (£6.95) a barrel, the lowest since 1998. The last time the oil price crashed in 2014, Russia was plunged into a deep recession. While the Kremlin says it has enough in its $125bn (£103bn) sovereign wealth fund to weather the storm of low oil prices for six years, a long-lasting contraction in the industry could hurt Russia’s economy, experts say.

The country’s GDP fell more than 28pc in April, a symptom of the low oil prices and the lockdown measures being used to battle Covid-19.

According to Russia’s finance ministry, this amounts to a hit of more than $33bn (£27bn) for the month, around a third of which can be attributed to oil’s collapse. Even in Britain, the crash may accelerate the death of the North Sea.

A recently released report suggested that more than a third of North Sea oil and gas reserves may be uneconomical. Some academics and politicians say the research, by the University of Aberdeen, diminishes the economic argument for Scottish independence.

Researchers have found that an oil price of $25 (£20) a barrel means that more than 3.9bn barrels – which accounts for 35pc of all available hydrocarbons in the North Sea – will be unprofitable to produce. The world over, oil producing countries like Angola – with budget breakeven prices of $150 (£123) a barrel – are hurting at a time of never before seen turmoil in the energy sector.

But even more sophisticated, larger oil producers such as Russia and Saudi Arabia have been battered by the downturn.

“There are no losers, there are only winners,” said Putin’s spokesman, Dmitry Peskov, the day after the new deal to cut oil output again was signed.

But in the long-run, the available evidence suggests that there will, in fact, be no winners, just losers.