The fall of oil prices brought on by Riyadh’s refusal to meet Moscow halfway on production restrictions amid concerns over coronavirus have swallowed up the financial world’s attention, with observers holding their breath on what steps the big three exporters are going to take next. By the look of things, Washington may be the first to blink.
On Tuesday, the US Department of Energy announced that “in light of the recent fluctuations in global oil markets,” it would suspend plans to sell oil from the Strategic Petroleum Reserve.
In a press statement, DOE spokeswoman Jess Szymanski explained that while the planned sale “was designed to raise revenue for SPR facility maintenance and upgrades…given current oil markets, this is not the optimal time for the sale.”
Tom Kloza, head of energy analysis at the Oil Price Information Service in Gaithersburg, Maryland, says that given recent events, cancelling the SPR selloff is the only rational thing to do, and may be the Trump administration’s effort to help stave off disaster for shale producers.
It's completely illogical “to sell oil out of the Strategic Petroleum Reserves when prices are under incredible pressure thanks to higher Saudi output, higher Russian output and now – the prospect of higher production from the UAE,” Kloza explained, referring to reports that Russia could soon ramp up output by 200-300k barrels per day (bpd) in the near-term, and the news that Saudi Arabia and the UAE plan to boost production by a million barrels each.
“It made no sense to be selling oil from the SPR in February and it is a completely crazy idea to continue selling now with prices plunging to such low levels,” UC San Diego economics professor Dr. James Hamilton argues. “The idea behind the SPR was to sell oil when it was needed in response to some emergency disruptions in supply. This is not remotely the case today.”
In fact, America’s reserves could actually stand to stock up on some more medium and sour crude at the expense of light tight oil, Kloza says, pointing to prospects for a recovery to $50 a barrel prices over the long term.
“So the suspension of the sale helps shale producers and makes sense,” the energy analyst notes. “There are lots of different opinions on break-even prices for US shale, but most observers would agree that prices in the low $30’s are either unsustainable, or the production of such crude is unsustainable.”
Shale's Crude Cutoff
For many US producers, shale becomes unviable at prices below $50 per barrel, meaning that the glut could have a serious impact on the US economy if it lingers. Oil and gas accounts for about 7 percent of the US’s GDP, with over 10 million Americans involved in the energy sector.
Unfortunately, Dr. Hamilton says, it’s unlikely that the DOE’s decision will have any real impact on prices. “The reason is that other development on the demand and supply side are so much bigger and more important than whether or not the US sells out of the SPR,” he says.
Ian Lee, associate professor at Carleton University’s Sprott School of Business, says the US may not be the only producer to be affected. “Oil prices are now below the breakeven price for Canada, the US and Russia,” he estimates. “If this continues, smaller and mid-size firms will fail and lay off employees. These events could precipitate a global recession.”
Saudi Arabia is the chief culprit in the current oil crisis, Lee says, and is “trying to force Russia to agree to production cuts by inflicting pain on Russia by deliberately pumping far more oil than the market needs – which causes the price of oil to collapse.”
According to the Reuters account of the Friday meeting of OPEC+ ministers, Saudi Arabia and its allies wanted to add 1.5 million bpd in cuts to the 2.1 million bpd already in place, with Russia rejecting the proposal, saying that existing cuts were sufficient.
On Monday, Russia’s Finance Ministry said the government was confident about being able to plug up any holes appearing in the budget due to the oil glut thanks to $150 billion in liquidity in the Sovereign Wealth Fund, and calculated that Russia could comfortably wait out $25-$30 per barrel oil for up to a decade.
“If they both have to tap their sovereign wealth funds, the Saudis would likely have to sell Treasuries, while Russia has already divested most of its Treasuries, though it is believed to be a large holder of Chinese bonds,” says Marc Chandler, managing director of Bannockburn Global Forex, a Cincinnati-based financial consultancy.
Chandler believes that it can't be ruled out that Riyadh and Moscow won't put their differences to bed by the next OPEC+ meeting in May or June.
Alan Li, portfolio manager at Atta Capital, a Hong Kong-based investment management firm, agrees, saying Moscow and Riyadh realize that they could “both get hurt” in the current situation, and that this realization could bring them back to the negotiating table. According to the investor, low oil prices are something energy-dependent economies must get used to anyway, as renewable energy sources may make high oil prices a thing of the past “maybe in the five or ten years” from now.
On Wednesday, Russian Deputy Energy Minister Pavel Sorokin told Reuters that OPEC had asked Moscow for an additional oil production cut of 300,000 barrels per day, for a total of 600,000 barrels daily, during last week's talks, with Russia considering this technically challenging to achieve.
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