Oil puts the brakes on its race to the bottom

In a moment of maximum concern, in which the world is holding its breath while waiting to know the true level of contagion in the economy from the Covid-19 health crisis, oil producers have spent weeks propagating extra microparticles of uncertainty and instability . The price of a barrel of Brent (the reference in Europe), which was trading around $ 65 when the first cases of coronavirus began in China, closed last Monday at $ 22.7, its lowest level since 2002. A collapse of more than 60% that had its logical explanation in the brutal drop in demand registered in recent weeks, but which had also been contributed by the strategic pulse in which two of the main producing countries, Saudi Arabia and Russia, were embarked. , flooding the market with crude just in a context in which nobody needs it. The first and great undisguised goal was to finish sinking rivals who were already heavily touched, especially American shale producers who use the technique known as “fracking.”

The recent mediation of Trump in the conflict, creating expectations about an imminent negotiation to redirect the situation, revived oil prices in the final stretch of the week (Brent closed on Friday at $ 34.1, after rebounding more than 33 % from its lows on Monday). In fact, and as confirmed by OPEC sources, a videoconference meeting is scheduled for tomorrow in which, predictably, it will try to stop the fall to the hells of crude oil with a significant cut in pumping (in his Twitter pulpit, Trump he even spoke of up to 15 million barrels a day). The white smoke for the black gold arrives or not, the truth is that its medium-term evolution remains unpredictable.

This is how the war started
To understand this strange scenario of double tension of supply and demand, one must go back to 2014. As Alberto Priego, professor of Political Science and International Relations at the Universidad Pontificia Comillas, explains, that year is remembered as the beginning of one of the greatest falls of the price of oil, “not only because of the emergence of ISIS and the control it exercised over Iraqi wells, but because from the US a path was started towards ‘‘ fracking ’’ which made it a self-sufficient country and the world’s leading producer of crude oil. ”

To prevent this new trend from consolidating, some states began to move. In this context, the creation of OPEC + is framed, an informal expansion of the oil cartel to other producing powers. The plan was to preserve the traditional, then-questionable power of control over the market of an organization that only produces around a third of global crude. Among the new partners stood out Russia, a true hydrocarbon giant that, until then, had acted as a free verse.

“In 2016, this group adopted a reduction in production in order to keep prices above $ 80. The agreement, which worked quite well, lasted four years and was due to be renewed at the beginning of this March. In other words, the energy ministers began to renegotiate just as the coronavirus began to spread throughout Europe. When everyone thought a new cut in production would be agreed, Moscow blew up the meeting with a rejection of the consensus that had prevented the collapse of crude oil since 2016, “explains Priego. Putin launched his order as a kind of coup d’etat: he refused to cut production. And Saudi Arabia redoubled the bet by announcing that it would break all the levees in its production, going from 10 to about 12 million barrels a day.

Production could be reduced by up to 15 million barrels a day to curb falling prices

Coordinated policies were blown up just before the formal end of the old production agreement (it expired definitively this Wednesday), and the price of crude oil was in free fall. What was the point of that extra downward pressure? “From the point of view of Russia and Saudi Arabia, a price war was quite rational. Both, but especially Saudi Arabia, are low-cost producers. Taking the oil out is very cheap, and that is why they took advantage of this circumstance to get rid of the competition, especially the US “frackers”, but also that of other high-cost producers such as deep-sea producers, in which many Latin American and African countries are included ”, underlines Gonzalo Escribano, director of the Energy and Climate Change Program of the Royal Elcano Institute.

Geopolitical strategies
The geopolitical component has had a great weight in this “fight of oil giants”. “US-Saudi Arabia relations have been deteriorating over the years. Of the 19 9/11 terrorists, 15 were of Saudi origin. Laws were promoted to sue the country as a subsidiary liable and several have prospered. Then came Saudi participation in Yemen, against American criteria; the suspicion that after the resignation (including kidnapping) of the Lebanese Prime Minister Saad al Hariri there were the Saudis; his approach to Russia … And, finally, the scandal of the murder of dissident journalist Jamal Khashoggi (implicating the crown prince himself). After this process, the American Administration approved the old Nopec project (which allows the cartels to set prices on oil). A direct attack on OPEC and Saudi Arabia », explains Luis Fernando Utrera, deputy director of the Master in Stock Market and MMFF of the IEB. “Saudi Arabia’s objective was also to crush Iran, with unsustainable production costs at those prices,” added Escribano.

Putin, Utrera argues, Trump’s decision to withdraw from the Middle East and not be an arbiter of warfare gave him “the opportunity to occupy that space and take control of the area. Meanwhile, Saudi Arabia used Russia to pressure the United States. But now she is a nuisance for her support for Iran, her traditional enemy. A complex three-way war (with China as an impassive spectator cramming its reserves with cheap crude) that was putting many players in the sector on the brink of collapse and threatened to leave victims safe. Because the truth is that at prices around $ 30 very few world producers can survive. “The dominant position is clearly held by Saudi Arabia, because it is the one with the most capacity, it can produce 12.4 million barrels per day, but above all because the cost of extraction of each barrel is less than $ 9. They are profitable even at very low prices »insists Joaquín Robles, analyst at XTB.

With costs also in the environment of between ten and fifteen dollars, Russia has some resilience, but its economic situation is much less solid. That, and the fear of the definitive impact of a health threat that continues to spread throughout the planet, also explains its backward movement. On Thursday, Russian Energy Minister Alexander Novak already stated that it was not “practical” for Russian companies to continue to increase supply.

Uncertain future
The possible agreement can stop the collapse of prices, but not clear all doubts. “I am not too optimistic about this agreement because it does not make strategic sense for Russians and Arabs and, in addition, there would continue to be excess supply,” says Utrera. The desert journey for the oil industry seems long. Different forecasts put the fall in world demand in March at around 25%, which will be greater in the coming weeks. And in the long term, the crisis unleashed by Covid-19 can mark a before and after for the energy sector. “The American shale oil companies were already having a hard time with prices between 50 and 70 dollars. Financial markets and investors had already somewhat lost faith in that model even before this price drop. And a certain retreat was being seen towards the entire sector in general, which will increase with the increasing perception of risk. Furthermore, if Europe is opting for a decarbonisation model, it is not easy that there will now be aid for energy intensive companies or for sectors that do not fit into the taxonomy that is already determining what is green or not. Today, investors are already looking at the risk of the carbon content of their investments. And in the current context they are going to think about it a lot. It can be a very fat stick for the sector, “says Gonzalo Escribano.

Although it seems that it has decided to stop running towards the abyss, the oil sector has not yet lost sight of it.

Infrastructures to the limit
The “double shock” to which oil was subjected (plummeting demand and a parallel increase in production) was causing an unprecedented situation in the market that threatened even the collapse of storage infrastructure. With a drop in demand of 20 million barrels per day, similar to that experienced in March, “global storage capacity would have been exhausted in three months,” explains Utrera (IEB). “Obviously, if such a strong inventory point had been reached, producers would have stopped pumping to try to dispose of their stocks. That is why we think that countries will have to agree in some way sooner or later, “says Joaquín Robles, analyst at XTB. At the moment, Trump has already taken advantage of cheap crude to strengthen the US strategic reserves. And now that China appears to be waking up from the Covid-19 nightmare, it has also stepped up its massive purchases of cheap black gold to fill its “energy pantry.” .

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