If you’ve been paying attention to the news lately, you’ll no doubt have heard much discussion regarding tensions between Russia and Saudi Arabia over the production, exportation and price of crude oil in the midst of the ongoing COVID-19 pandemic.
Widely dubbed the ‘2020 oil price war’ in the press, this major disagreement has led to the price of petroleum fuel reaching historic lows, in addition to having dramatic repercussions across a global economy already on its knees from lockdown-led stagnation.
In this special edition of KVB PRIME Insights, we examine how we got to this point and what the future may look like for the struggling energy market– so let’s start with the very basics; what do we mean when we talk about a ‘price war’?
What Does the Term ‘Price War’ Mean?
In economic theory, a price war is a competitive tactic of purposefully lowering prices with a view to undercutting rival businesses and ensuring your product becomes the most attractive of its kind to investors.
Generally speaking, what often happens is that other producers then quickly move to match (or better) this lowered price to remain competitive themselves, and the cycle typically continues until the price across the board drops so low as to be unsustainable, thus causing logistical unease to one or more parties.
Price wars are conducive to near-term revenue increases as they can greatly boost a company’s market share in a short timeframe if competing organisations are unable to effectively counter; it is not unheard of for some companies to even sell at a loss for a time in order to be seen as the most affordable provider.
However, economists tend to advise caution against entering into them regularly (or for long periods) because of the loss of profit they necessarily entail; for example, even a 1% decrease in price can quickly compound into an overall 10% profit loss due to knock-on effects to the bottom line.
In addition, with more fundamental commodities such as energy, the implications of such a sudden drop in prices can easily have devastating effects across the wider supply chain, as we’ll examine more below.
Further reading: https://www.investopedia.com/financial-edge/0810/the-pros-and-cons-of-price-wars.aspx
What is the OPEC+ Alliance?
The beginnings of the current oil price war (and the wider ongoing geopolitical tensions) can be traced back to September 2016, when Saudi Arabia — a prominent producer of crude oil and the de facto leader of the Organization of the Petroleum Exporting Countries (OPEC) — agreed to begin collaborating with Russia to monitor and regulate the price and production of oil to ensure market stability.
This new partnership led to the creation of an informal (yet extremely powerful) regulatory alliance known as OPEC+, which is generally agreed to consist of the original 13 OPEC nations and Russia, alongside 10 other oil-producing countries such as Kazakhstan and Mexico.
The incorporation of these new states into the OPEC sphere meant that the organisation’s already-substantial impact on the world stage was increased further; its full-time members are estimated to control a combined 35% of global oil supplies and approximately 82% of the world’s proven oil reserves. With the addition of these new unofficial participants, these figures were raised to around 55% and 90%, respectively, giving the partnership an overwhelming influence over the global fossil fuel market.
By January 2020, the OPEC+ group had cut worldwide oil production by 2.1 million barrels per day, with Saudi Arabia cutting its production the most out of any participating nation.
Further reading: https://www.forbes.com/sites/arielcohen/2018/06/29/opec-is-dead-long-live-opec/#3218f5302217
How Did the Russia-Saudi Arabia Price War Come About?
The current price war began in earnest on 8th March 2020, triggered by Saudi Arabia in response to Russia’s refusal to curb its production of crude oil, which OPEC+ deemed necessary to keep the price at a steady level.
This was largely due to a dramatic decrease in worldwide demand and consumption during the first quarter of the year, both of which were brought on by the coronavirus lockdown measures implemented by world governments since the beginning of the COVID-19 outbreak.
Russia rejected these plans and declined to continue its participation in the negotiations, effectively dissolving the OPEC+ partnership as a cohesive unit. The ensuing tensions resulted in an unprecedented drop in global oil prices throughout March and April as consumption remained low while production continued.
Various international efforts to broker a resolution (led by US President Donald Trump along with the G20 members and International Energy Agency (IEA)) followed, including video conferences on 9th and 10th April that resulted in OPEC and Russia eventually agreeing to a reduction of 10 million barrels per day between them.
However, these efforts were seemingly in vain, as the mounting pressure surrounding the market led to further catastrophic declines in the days and weeks that followed.
What Effect has the Oil Price War Had on the Global Energy Market?
As a result of the price war and the wider stock market difficulties, the price of oil turned negative for the first time ever on 20th April due to a lack of oversupply storage facilities — with WTI crude futures contracts reaching as low as -$37.63 per barrel — meaning production firms were forced into the surreal position of having to pay individuals to take excess crude petroleum off their hands.
Some commentators have suggested this steep drop-off is partly due to many investors essentially cutting their losses, abandoning their May contracts and moving straight on to June (by which time, they hope, the pandemic situation may have begun to improve) — opining that the negative drop could be written off as a one-off fluke; a perfect storm of price competition, low demand and a global pandemic.
Despite this, it seems that the crude futures market isn’t out of the woods yet; at the time of writing, WTI futures for June delivery are still hovering around the $15-$20 mark, and while this is a sure improvement over the recent negative rates, it remains a price that most production companies won’t be able to survive on for long.
Indeed, Jeff Miller, CEO of prominent oilfield services firm Halliburton — which incurred a net loss of $1bn during the first quarter of 2020 — confirmed the market’s glum outlook in a recent statement, noting ‘We expect activity in North America land to sharply decline during the second quarter and remain depressed through year-end, impacting all basins’.
Further reading: https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/oil-price-war-seen-exacerbating-slump-in-global-economy-57647691
What Lasting Impact Could the Oil Price Crash Have on the Wider Energy Industry?
With May contracts having only just expired and the next few months’ outlook still uncertain, it’s simply too early to tell what effects recent events will have on the market in the long term — though some analysts warn that a return to familiar levels of demand around 100 million barrels per day looks unrealistic for the foreseeable future.
In fact, there has already been speculation that the unprecedented crisis, and the way it has forced businesses and citizens alike to adapt — for example, greater supply chain efficiency, limiting mobility and a reliance on remote communication — may have accidentally lead to the late-2010s representing the historical peak of oil consumption ahead of a more cautious, renewable-focused future.
On the other hand, it could well be true that demand gradually returns as the restrictive lifestyles necessitated by the pandemic fade into a bizarre, nightmarish memory; at present, the fate of the oil industry seems to rest on just how differently life will be remodelled in the post-COVID world.
