On April 20, the price of West Texas Intermediate (WTI) oil grade turned negative for the first time in history, reaching – $37.63 per barrel (pb). The shock of the collapse was so great that traders were quick to call that day “Black Monday”.
Although the slump was specific to the WTI May futures contracts and hit mostly speculators who were trying to play with the ups and downs of the oil market, it affected oil trade elsewhere too. The price of Brent oil, which is used as a reference for traditional oil producers in Europe, Russia and, to a certain extent, in the Gulf, fell from $26 on April 20 to $16pd two days later.
What happened with the WTI futures for May is a warning sign of what is to come. Oil producers will face major difficulties in the future, which will be detrimental for Gulf oil-producing countries as well as Russia.
A bleak picture
The global oil market has been hit by an unprecedented oversupply. It was experiencing already high oil output as a result of oil production increases in the US and Canada and in some other non-OPEC+ countries when the COVID-19 outbreak was announced in China. The lockdown in Wuhan, a major industrial hub, sent prices tumbling from $68pb at the beginning of the year to $53 in early February.
As the outbreak grew into a pandemic, affecting countries around the world and causing industries to shut down and travel to be cut off, oil lost some 50 percent of its value. As analysts projected a global drop in demand from 100 million barrels per day (mbpd) in 2019 to 90mbpd in 2020 on average, some producers continued to increase production, making the situation even worse.
The OPEC+ deal announced earlier this month was supposed to help stabilise prices, but the situation does not look promising. Oil exporting countries participating in the deal agreed to decrease their total output by 9.7mbpd, but this would not be sufficient to immediately improve the situation.
In April, demand dropped to 72.5mbpd, while global output stood at 101mbpd. Under these circumstances, in May and June, when the oil demand is expected to rise by just 9mbpd, the cuts agreed in the OPEC+ deal will still not be enough to eliminate the oversupply.
Afterwards, demand recovery will be slow and dependent on the dynamics of the COVID-19 pandemic. If there is no second wave of outbreaks, the world oil demand could return to 2019 levels by the end of 2020.
Yet, even this situation does not mean oil market stabilisation by 2021. The global economy will still be “burning” extra barrels of oil accumulated in reserves during the oversupply peak of the first half of 2020, stretching the period of low oil prices beyond January 2021.
The situation is additionally compounded by the fact that some oil producers, part of the OPEC+ deal, may fail to immediately decrease their output in May to fulfil the commitments they have made.
Experts doubt that Russia will be able to make all necessary preparations in time to bring oil production down from 11mbpd to 8.5mbpd immediately on May 1, as required by the deal. Some also argue that Russian oil companies are worried about the high cost and technical issues of subsequent oil output resumption in northern regions of the country and at the older oilfields.
The Kremlin cannot really force the big Russian oil companies to comply and is instead looking for alternative solutions. Moscow already insisted on the exclusion of the oil gas condensate from OPEC+ production cuts and there is also speculation that Russian companies will be allowed to burn produced oil instead of closing oil wells.
The Gulf Cooperation Council (GCC) members also do not appear completely committed to common action on the oil market. Saudi Arabia has started making preparations to implement the cuts agreed on in the OPEC+ deal, but it continues to offer discounts on its oil, trying to upend other suppliers on the Asian market. This will further destabilise the oil market.
Another major problem is the lack of available space in oil storage facilities across the world. This played a major role in the WTI collapse and will likely continue to present a major challenge, as producers run out of space to store extra oil.
Currently, every storage option is being considered by oil producers, ranging from large-size tankers and ground storage to pipelines and smaller vessels, but these too are rapidly being filled. A number of oil producers might run out of storage space in May, others – in June.
Looming crises in the Middle East and Russia
The possibility of oil prices slumping even lower in May or staying extremely low in the long run (below $30pb) spells trouble for the Gulf oil producers and Russia.
First, lower prices will likely intensify competition for consumer markets. Given the oversupply, major buyers, like China, are unlikely to stay “loyal” to their traditional suppliers and will simply opt for those who are willing to give a discount. This means Russia and Saudi Arabia may face fierce competition for Chinese market shares from West African, South American and North American companies.
Second, if not resolved, the lack of storage will inevitably force oil suppliers to undertake additional production cuts which, in the case of Russia, might prove too costly or even risky in terms of oil well stability.
Third, oil prices potentially falling below $20pb means that oil exports are not going to bring much profit to the majority of the Gulf and Russian oil producers, given that the average cost of oil production in these countries is between $9 and $20pb (and up to $44pb for new projects)
Thus, it is expected that the GCC and Russia, which were already running significant budget deficits, will suffer major revenue cuts this year.
In 2020, the breakeven oil prices for the GCC budgets varied from $40pb for Qatar to $76pb for Saudi Arabia; for Russia, it is $42pb. Gulf countries have already started cutting their expenditures, which will probably continue into 2021. As has happened in the past, this will affect social security programmes, public expenditure and the employment of expat workers.
GCC countries have also announced stimulus packages, ranging from $16.5bn in Kuwait to $70bn in the UAE, to try to prop their economies and cushion their populations from the impact of the economic crisis. It has been reported that Russia plans to unroll a $14bn plan to counter the effects of the COVID-19 epidemic on its economy.
According to estimates, the Saudi economy will decline by 2.3 percent, Russia’s – by between 4 and 6 percent – if oil prices remain at around $35pb.
The current crisis caused by the pandemic and low oil prices might also have negative political implications. While the smaller GCC countries are unlikely to face any destabilisation, this is not the case with Saudi Arabia and Russia.
Both of these countries are passing important intra-elite transformations spurred by the desire of President Vladimir Putin and Crown Prince Mohammed bin Salman to guarantee their prolonged stay in power.
Both Moscow and Riyadh are involved in foreign policy adventures that might be costly for their budgets amid this crisis and both face the potential danger of social unrest due to grave socioeconomic problems that the two countries suffer from.
All in all, both Russia and the GCC should be prepared for challenging times ahead. Their misfortunes are not going to end any time soon.