Commodities

The oil market disrupted

The oil market disrupted

The price war between Saudi Arabia will squeeze US producers, who are already facing the wild card of the US presidential election in November.

Riyadh has disrupted the oil market by opening the tap and offering oil at discounted prices, leading to a decline in prices at one stage to USD31 from USD50, recalling similar events in 1996 and 2014. The Kingdom has the lowest production costs among all producers—about USD4 per barrel, compared with USD in the case of Russia. So, it appears well positioned to withstand a prolonged period of very low oil prices, even if the consequences for the Saudis’ already strained finances would be severe. The ball is now in Russia’s court although it too could ride out low oil prices for a while. If Moscow comes back to the negotiating table, the Brent price could quickly rebound back to the USD40-45 range. If nobody budges, the price could remain in a USD30-40 range for a number of weeks.

 

Eventually, the decline in oil prices could reduce oil production, notably from the US. Small US shale oil companies appear particularly vulnerable at this juncture. Most small US shale oil producers are highly indebted and are now impacted by a widening high-yield corporate-debt spread. Ironically, any decline in prices could coincide with a resumption in demand could also resume if and when quarantine measures are lifted in Europe and the US. In this scenario, the Brent price could move back to the USD40-50 range in Q3 2020.

 

The US November presidential election is a wild card a little further out. The election of a Democratic candidate could open the way for new environmental laws less favourable to the oil industry. This could limit the expansion of the US oil industry and help pushing oil prices higher at the end of this year.

 

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