Oil at $20 no more a dream but distinct possibility; Market has only one way to go-downwards

A heady cocktail of ego, frustration, power struggle and one-upmanship is what has led to the current commotion in the oil market, which is of course welcome news for consuming countries like India. After shedding a third of its value, crude has since made some marginal recovery, but the overall trend continues to be downward, with new predictions putting the price in the early $20s.

The coincidence of the Saudi move to aggressively cut the price, targeting to hit Russia for its intransigence over output adjustments, with a reassertion of power by Crown Prince Mohammed bin Salman has not gone unnoticed. After keeping a low profile for his alleged involvement with the murder of journalist Khashoggi, the crown prince is back in action with a vengeance.

Prone to impulsive behaviour nurtured by royal pampering, the heir apparent to Saudi kingdom decided to launch the price war to punish Russia for failing to cooperate with a price-boosting production cut. It is a different matter that the move will cost the kingdom dearly as it will have to draw down heavily from the reserves to overcome strain in the exchequer.

Oil prices could fall into the low $20s for the global market to rebalance, as analysts expect an increase in global supplies in the next three months. OPEC+ countries are locked and loaded to add between 1.5 million and 2.5 million barrels per day (bpd), which is considered as a realistic short-term capability.

After the breakdown in OPEC+ negotiations and subsequent oil price free-fall, Saudi Arabia and the UAE have both signalled their intention to flood the market with additional oil production starting next month.

“Without OPEC+, the global oil market has lost its regulator and now only market mechanisms can dictate the balance between supply and demand,” says EspenErlingsen, Rystad Energy’s Head of Upstream Research.

Rystad Energy estimates that global liquids demand was reduced by around 4 million bpd in February, primarily driven by the coronavirus. Over the next months, demand might be weakened by between 2 million to 4 million bpd due to the virus. In terms of strategy, the Saudi action signals a move away from market price to market share at a time when the market is already reeling from severe demand destruction.

According to S&P, demand for the first quarter is likely to fall 2.4 million barrels per day (MMBD) with a U-shaped recovery, which will not see demand growth move back closer to normal trend levels until the second half of the year where there could be a small rebound. In contrast, despite losing 1 million barrels per day (MMBD) of Libyan, 350,000 barrels per day (MBD) of Venezuelan and 400, 000 barrels per day (MBD) of Saudi production, oil production has been up year-over-year. And it is closer to 1 million barrels per day, due to record US production and growth in other non-OPEC production such as Brazil, Guyana, Canada and North Sea, plus 400,000 barrels per day of OPEC non-compliance from UAE, Iran and Nigeria.

With increasing number of reports of the Coronavirus across the world, demand continues to look uncertain. On the supply side, a market share strategy could see Saudi Arabia production jumping 800,000 barrels per day (MBD) to around 10.5million barrels per day (MMBD), which along with the other OPEC countries throwing off their gloves could see OPEC and Russian supply adding well over an additional 1 million barrels per day (MMBD) to the market.

The conditions are unprecedented and the market is keenly watching which producer blinks first. While low prices will test Saudi fiscal balances, they have the lowest cost barrels and with low debt can pull on sovereign reserves and take the pain.

Analysts believe Russia may simply allow the Rouble to slide in order to sustain flow of Roubles into their economy while US Shale will certainly take the brunt of the pain - their production unlikely to change quickly with much activity already committed and significant volumes hedged and protected.

According to the experts, without any positive signals on demand or evidence of any supply agreements, the market has only one way to slide, and with contagion expected to widen, even the back of the curve will lack any confidence - especially if the market also assumes the return of Libya, and even Iran at some point, over the next 12 months