Oil price falls below $40 per barrel spell problems throughout the industry, with companies and countries alike facing tough times.
OPEC had hoped to cut 1.5 million barrels per day of production at the meeting in Vienna last week. Of this amount, the group would provide 1mn bpd of the reduction while the outlying members making up OPEC+ were expected to remove 500,000 bpd.
Russia, which has been a member of the OPEC+ group since December 2016, was not playing ball. As a result, not only have the new cuts failed to take root but the existing reduction of 2.1mn bpd will also end as of April 1. This comes as coronavirus is depressing demand, with the International Energy Agency (IEA) cutting its 2020 demand forecast by 1.1mn bpd.
Saudi Arabia has responded to the breakdown in communication with Russia by slashing official selling prices (OSPs) – particularly to Europe. Reports have suggested Saudi is preparing to boost production from its current 9.6mn bpd, perhaps to as high as 12mn bpd.
Virtually all producers are under water as a result of the rapid price declines. The International Monetary Fund (IMF) has external breakeven prices for Middle East and North African producers ranging from $42.4 per barrel for the United Arab Emirates to $77.8 per barrel for Bahrain.
Saudi and Russia are well prepared for this price war, with both holding billions of dollars of reserves. Moscow also benefits from a flexible exchange rate, unlike Saudi.
Other countries are not so fortunate. Nigeria and Angola have set their budgets at levels of $57 and $55 per barrel respectively, while Ghana set a benchmark of $62.6.
Investec’s head of commodities Callum Macpherson noted two more potential pitfalls for oil. The first was a resolution to Libya’s civil war, which could see 1mn bpd of production brought back to the market. The second was if coronavirus disrupts the US driving season, which could have “very serious” consequences for demand.
Companies will also be unable to make ends meet as a result of the low prices. The majors have breakevens ranging from $40 for OMV to $74 for ExxonMobil, according to research from Redburn Energy. There are also particular strains on companies with higher debt loads, such as BP, whose gearing is at 31%.
Redburn has suggested Shell is likely to opt to return to scrip dividends, rather than cash, as might Equinor and Eni.
Cantor Fitzgerald Europe’s oil and gas analyst Jack Allardyce said that prices would need to rebound eventually as “current levels are below the marginal cost of production for the majority of operators, including all the US shale basins. Sub-$40 isn’t sustainable for any longer than a short period, most likely just months.”
Wood Mackenzie’s head of upstream analysis Fraser McKay said that should prices remain below $40 there would be a “new wave of brutal cost cutting. Discretionary spend would be slashed, including buybacks and exploration. But given the lack of excess in the system, the cuts to development activity will be necessarily fast and brutal. US tight oil development activity, though not as flexible as many believe, will react immediately.”
McKay went on to say conventional projects not yet sanctioned would be delayed, while maintenance and other works scaled back.
There have been suggestions that Russia opted to force the OPEC break up in order to punish US shale producers, which have been enjoying the results of price stability while not carrying the same level of pain.
This idea plays into new narratives of a return to Cold War narratives but this seems unlikely to be the single motivating factor. The previous effort by OPEC in 2014 to tame the US shale industry ended in abject failure, making it seem unlikely this mistake would be repeated.
The previous price crash did send a number of US producers into bankruptcy, but this largely allowed debts to be wiped out and assets sold on – while continuing to produce. This price drop is likely to spur further consolidation in the shale arena as large companies can play the longer-term game.
Larger players are also integrated throughout the value chain, balancing their upstream assets with mid- and downstream holdings. As the price of crude falls, margins for refineries improve, although demand woes will be a concern.