News Analysis | Why oil prices are crashing
Prices crashed by almost 50% this year, from $66 a barrel on December 31, 2019 to the current levels, primarily driven by lack of demand.
Oil prices saw their biggest single-day crash in almost 30 years on March 9, throwing global equity markets into turmoil. The price of a barrel of Brent crude closed down 24% at $34.36 after a price war was initiated between Saudi Arabia and Russia, two of the world’s largest oil producers. It recovered slightly on March 10, but crashed again. On Thursday, Brent crude price was hovering around $33 a barrel. Prices crashed by almost 50% this year, from $66 a barrel on December 31, 2019 to the current levels, primarily driven by lack of demand.
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What happened to the OPEC-Plus alliance?
After 2014 “glut” diplomacy which brought down prices below $30 a barrel, Saudi Arabia and Russia came together to cut output and steady prices. Known as the “OPEC Plus” arrangement (Russia is not a member of the Organisation of Petroleum Exporting Countries, or OPEC), this alliance kept production lower and pumped up the prices. The OPEC-Plus cooperation collapsed last week after Russia rejected a Saudi request to effect more cuts in output given the fall in demand owing to the economic impact of the coronavirus outbreak. The exiting output reduction deal is set to expire later this month. The Russian and Saudi sides have said they are no longer constrained by the deal and are free to ramp up production. Saudi Arabia’s oil giant Aramco announced that it would increase output from 9.7 million barrels a day now to 12.3 million barrels a day in April. Aramco also offered a discount to its variety of crude, targeting Russian markets in Asia and Europe. The fear of glut at a time of slowing demand (supply and demand shock) rattled the markets, crashing prices.
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What does Saudi Arabia want?
As it was clear that Russia was not ready to cut its output further, the Saudis moved to the attack mode. The plan is to flood the markets with Saudi oil and depress the prices, which would hurt all oil exporters. Riyadh may have multiple targets. One is to exert pressure on Russia and make it come back to the negotiation table. And if both sides agree to a new deal, they can reverse the decision to ramp up production and collectively take steps to pump up prices. Second, if the Russians do not blink, the plan is to capture market share from Russia with discounts. Third, bleed the U.S. shale oil producers who could not sustain production at depressed prices. In a way, Crown Prince Mohamed bin Salman, the de facto ruler of the kingdom, is trying to take on both Russia and U.S. shale oil companies with a single move. But the question is whether Saudi Arabia could sustain the price war for a longer term. Roughly 90% of Saudi budget revenues are coming from the petroleum sector. The Kingdom wants prices to be over $60 a barrel to balance its budget. Prolonged depressed prices will leave a bigger hole in the Saudi budget, complicating further the Crown Price’s economic reform and diversification agenda.
What’s Putin’s plan?
Though Russia had been cooperating with OPEC for three years, there’s a growing opinion in Moscow that the output cut was hurting Russian energy companies. Russian companies also want to open the taps and gain more market share. Furthermore, there’s a convergence of interests between Saudi Arabia and Russia in hurting the U.S. shale oil companies, which are flooding markets with shale oil and challenging the supremacy of traditional oil producers in determining the prices (U.S. output was more than 12 million barrels a day in February). Russia is in a relatively stronger economic position than Saudi Arabia. Oil now accounts for less than a third of its budget revenue. The country has also built a war chest of $435 billion in foreign exchange reserves. Russian President Vladimir Putin may be in for a long game — to weaken both U.S. shale oil industry and the OPEC’s clout in the market.
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