Oil, the war on prices and the economic effects of coronavirus

Article
Michele Masulli
oil coronavirus

The price of oil has dropped by 30% in recent days, reaching levels close to all-time historical lows. An event that has made its way into the discussions of the world’s largest countries and financial markets, already affected by the spread of the coronavirus.

The price of a barrel has not registered such a decline since 17 January 1991, the very beginning of first Gulf War. What has happened? And why has this situation occurred? There are many factors. First of all, the tensions between the producer countries are becoming more difficult.

On Saturday, Saudi Arabia reduced export oil prices by almost 10%. The consequences were immediately felt. Brent fell by about $11 a barrel, to an exchange rate of $31 before rising to $35, and the WTI reached a minimum of $27.3.

Futures fell by about 3% and the stock exchanges, from the Pacific to the Atlantic via the Old Continent, recorded significant losses. Saudi Arabia’s decision followed a rupture within Opec Plus, the alliance that for three years has brought together the producer countries on the Moscow-Riad axis. Following months of tension, Russia rejected the proposal, driven by Saudi Arabia, to reduce production (already decreased by 4.4 million barrels per day since November 2016) by a further 1.5 million barrels.

This could, in part, be a reaction to the health crisis of these weeks. The coronavirus is affecting the global economy and, consequently, the demand for oil. In anticipation of this decline, the price of a barrel had already fallen by about $20 from when Covid-19 had been announced in China, a country that absorbed 14% of global oil demand and accounted for more than 80% of its growth in 2019.

However, while Russia claims to be able to withstand a prolonged period of prices of between $25 and $30 a barrel (Goldman Sachs also foresees a reduction of up to $20), at the cost of funding sovereign reserves, Saudi Arabia, by choosing to lower prices, has given rise to a general increase in production. Saudi Aramco has announced it will release 2.6 million barrels per day more onto the market, an increase of 25% compared to current production. “From April 1, there will be no more restrictions on production for Opec or non-Opec countries,” Russian Minister Alexander Novak said as he left the Opec Plus summit.

A price war for market share control (Iraq has already applied list discounts) in exceptional conditions is thus foreseen. If on the demand side we are witnessing a negative shock due to the weakness of the global economy, on the supply side there is, instead, a positive shock, driven by a downward trend in prices.

There could be many who will suffer the consequences, from Venezuela (a Russian ally) to Iran (a bitter enemy of the Saudis), as well as American oil companies, targeted by Russian measures.

However, it is the market shares of American shale oil and shale gas associated with it that are threatened. Current prices are far from breakeven and are hindering the development of new shale resources. US Oil & Gas bonds have showed substantial losses, with high risks of default, to the point of the speculation of State Aid by the Treasury.

It is no coincidence that US President Donald Trump has rushed in to blame the skirmish between Moscow and Riyadh on Twitter: “Saudi Arabia and Russia are arguing over oil prices and flows. This, and the fake news, are the reasons for the drop in the market!”. The black gold market was also the focus of a conversation between Trump himself and Saudi Crown Prince Mohammad Bin Salman on Monday. “Yesterday, President Donald J. Trump spoke with Crown Prince Mohammad Bin Salman of the Kingdom of Saudi Arabia. The President and Crown Prince discussed global energy markets and other important regional and bilateral issues,” White House spokesman Judd Deere said.

However, the European oil sector is suffering greatly as a whole with the Euro Stoxx 600 Energia index, the stocks of the Italian Saipem, Tenaris and Eni, those of Total, BP, Royal Dutch Shell, as well as the Russian Rosneft, recording double-digit losses, taking the sector’s capitalization back decades.

Saudi Arabia is also undergoing some setbacks. The stocks of Prince Bin Salman, taken in a climate of infighting (the news of the arrest of three members of the royal family on Saturday), caused a fall of more than 9% in Saudi Aramco’s shares, bringing them below the IPO placement price in December, and a fall of 8% on the Riyadh Stock Exchange.

What are the consequences for Western consumers? They will certainly benefit from the reduction in oil prices, but the prospect of deflation in a recessionary environment will imply significant risks.

Translated by Camilla Palla

Research Fellow dell'Istituto per la Competitività (I-Com). Laureato in Economia e politica economica presso l’Alma Mater Studiorum – Università di Bologna con una tesi sulla mobilità intergenerazionale dei redditi. Successivamente ha conseguito un master in “Export management e sviluppo di progetti internazionali” presso la Business School del Sole24Ore. Attualmente è dottorando di Economia presso il Dipartimento di Economia dell'Università degli Studi di Roma Tre.