What happened to the booming Oil Industry?

The oil industry is one of the most important industries in any country. It has a direct impact on the country’s currency value and balance of payment, and the overall revenue-generating capacity. Amid the rise of coronavirus pandemic across the world, oil prices have fallen to $20-$30 per barrel range (Brent Crude - $27.95 per barrel and WTI Crude - $21.51 per barrel) from $60 per barrel a few months ago. What exactly happened and what may be the road ahead for the industry?

BACKGROUND

It all started with the spread of Coronavirus. The virus had started discouraging people to travel. Thus, the number of flights operating started dropping. This gradually was reducing jet fuel demand. US shale companies, on the other hand, were preparing for an oil production increase in February amid lowering oil demand globally. Hence, oil prices from January 2020 had started falling gradually from $60 to $50 per barrel. However, as the coronavirus started spreading rapidly by February, several countries started imposing lockdowns. It spread panic in the market and pushed the oil prices below $50 per barrel when Saudi Arabia decided to take action.

In an attempt to brace for an impact from coronavirus outbreak, OPEC was considering a production cut of around 5,00,000 barrels per day (bpd) till June 2020. To discuss the idea with its new member Russia in the OPEC+ alliance, an emergency meeting was rescheduled from March to February. While Saudi Arabia was pushing a production cut of around 1 million bpd, Russia stayed reluctant for a cut as low as 6,00,000 bpd. With Russia and Saudi Arabia unable to come to a consensus, Saudi Arabia in an attempt to maintain its market share, confirmed to increase oil production to its maximum capacity as high as 13 million bpd. The oil prices in March thus reached to $30 per barrel level

At such low prices, the US shale companies are highly affected. Some may even face bankruptcies if low prices persist. Saudi Arabia as well would be affected by low prices because the entire country depends heavily on oil revenue. This fall in price may widen its budget deficit. However, Saudi Arabia went ahead with its plan and pulled the oil prices down to what we see today. Russia is also impacted, however, it has an edge over the OPEC and US companies.

Coronavirus pandemic is rising in India and India is under lockdown. International, as well as domestic flights, have been shut. India, the third-largest oil importer, has stopped importing oil amid this lockdown. Across various countries, airlines have completely stopped operations due to lockdowns. This is pulling the oil demand even lower. Adding to the low demand and panic, lowering oil prices by Saudi Arabia is making matters worse for oil companies, especially in oil-exporting countries.

IMPACT

For simplicity, let us focus deeply only on Russia, Saudi Arabia, and the US.

If we apply basic oil economics in this situation, Russia’s budget may break even if the Brent Crude price is at $40 per barrel; Saudi Arabia’s budget may break even if the Brent Crude price is $84 per barrel; the US shale companies may break even if the Brent Crude price is around $90 per barrel and WTI at around $80 per barrel.

At the current Brent Crude price of $27.95 per barrel and WTI Crude price of $21.51 per barrel, it is sufficiently clear that the US shale companies cannot continue production and some may even face survival issues. While Russia may still survive at $25 per barrel for 10 years (by utilizing its foreign asset reserves), Saudi Arabia can manage for not more than 2 years.

Hence, Saudi Arabia’s oil price war initiation is going to backfire if not withdrawn soon. If the war continues, Saudi Arabia, which depends heavily on oil for its revenue, will not be able to fund its key industries and will eventually default in its corporate and sovereign debt fund payments. Other OPEC, who also suffer lower export value, may pressurize Saudi Arabia to withdraw.

Moody’s and Fitch Ratings recently downgraded Russia’s economic outlook for 2020. Moody’s expects its GDP growth rate to be around 0.5% compared to 1.5% earlier. Russia also admitted that the oil price war would bring its GDP down by around $39.5 billion.

Countries relying on hydrocarbons for revenue generation and exports are more vulnerable to oil prices. Hence, countries like Russia, Oman, Kuwait, Angola, Iraq, Bahrain, etc. will be impacted by low prices. However, Russia can still survive the impact because it generates revenue from diversified streams. Saudi Arabia, on the other hand, relies heavily on oil export as the major source (~75%-80%) of revenue. This positions Russia on the winning side of the war.

US shale companies that have around $86 billion of rated debt and have already filed bankruptcies of $121.7 billion in the last few years, face a major crisis amid the war. Some of the analysts anticipate more bankruptcies to be filed this year if these low prices persist. To help the US oil industry, Trump may impose a fee on imported oil or products on a variable basis. This seems to be the only way to rescue the tumbling US oil industry.

Apart from these three countries, major oil companies in other countries like Nigeria in Africa are also suffering. The focus now is to retain the customers and pump oil to maximum limits to brace for future impact.

The oil price war observed a major hit on global oil stocks. Oil stocks in Europe and the US plummeted around 6% while the 10 year US treasury yields fell 0.5%. Panic selling was observed making matters worse for oil companies.

THE ROAD AHEAD

Sources say that the US and Saudi Arabia along with other OPEC is considering forming a cartel. However, that is just an idea and no confirmation has been received yet. If the cartel is formed, US shale companies may get an extended breathing space. US is also trying to pressurize Saudi Arabia to end this price war but to no avail. However, long-term survival for both Saudi Arabia and the US may remain skeptical.

The oil market is oversupplied at the moment. It can balance out only when demand rises considerably. The demand will rise when heavy oil importers like India and China are back. While India is under lockdown and Chinese oil giant PetroChina is cutting on its capital expenditure (CapEx), it is difficult to say if the demand will rise to required levels at least in 2020.

Uncertainty about the coronavirus pandemic may add to the woes of oil companies. The road ahead for the oil industry in 2020 seems quite bumpy. Only once the virus impact settles, oil companies may be able to recover. Meanwhile, oil companies need time to clean their balance sheets and extend their credit lines.

- By Ria Vaghela

Ria Vaghela is a Finance student who writes Financial and Economic articles. Her articles are regularly published in the youth media platform, The Representative Media. She also writes articles for her blog, Blogs on Markets. Her articles focus on reporting and explaining key financial and economic events and concepts in a simplified language. Learn more about Ria’s articles by visiting her blog at blogsonmarkets.in