Crude oil collapse highlights the global virus disruption

Ole Hansen

Head of Commodity Strategy

Summary:  Crude oil is currently rebounding after suffering its own black Monday bloodbath. The combination of the biggest demand shock since 2009 and Saudi Arabia and Russia abandoning their production cut deal has left the market in a flux. With the coronavirus expected to have a prolonged impact on demand, the focus now switch U.S. shale oil producers. Some of these are now undoubtedly forced to cut production as the price slumps below their breakeven level


Crude oil is currently rebounding after suffering its biggest crash since 1991. The 10% gain seen so far this Tuesday comes after one of the world’s most important commodities experienced its own black Monday bloodbath. At one stage it was down by more than 30% from Friday’s already weak close with energy companies suffering major losses as well.

Behind these developments we find the coronavirus which continues to spread havoc across the world. While China is slowly recovering, something that was highlighted by President Xi’s visit to Wuhan today, the rest of the world is still seeing an acceleration. Currently in Europe and not least in the U.S. where the government’s efforts have been woefully inadequate so far. Not helping the situation there is the fact that the virus has become a political hot potato. A survey found that 62% of Republicans saw the news coverage about the seriousness of the virus being “Generally exaggerated” compared with 31% among Democratic voters.

Into this growing uncertainty the oil market, already faced with the biggest demand shock since the global financial crisis, now has to deal with a major jump in supply. This after both Saudi Arabia and Russia have entered a price war following their failed production cut negotiations in Vienna last week.

The International Energy Agency has cut its 2020 world oil demand forecast to negative 90,000 barrels/day. Just two short months ago before the virus became known outside China the IEA had forecast an increase of 1.2 million barrels/day. The U.S. Energy Information Administration and OPEC will release their monthly reports Tuesday and Wednesday.  

Saudi Arabia started the war by announcing on Saturday that it would cut its April official selling prices (OSP’s) to Europe, Asia and the U.S. by between 6 and 8 dollars per barrel. As a result of these deep discounts Saudi Aramco has said it will supply 12.3 million barrels/day next month, up from less than 10 million barrels/day in recent months. Being above its maximum sustained capacity the order will be met by delivering oil from storage facilities around the world.

Russia’s energy ministry meanwhile has called a meeting with Russian oil companies Wednesday to discuss future cooperation with OPEC. Rosneft, Russia’s state oil company meanwhile has said that it will boost production as soon as the current OPEC+ deal ends, initially by 300,000 barrels/day.

With supply on the rise, demand shrinking and the prices falling to levels no producer can sustain in the long term, traders and analysts are now asking what is going to give in order for the market to stabilize and for the price to recover. The Wall Street Journal reports that former Saudi energy minister Khalid al-Falih, was in talks with Mr. Novak in an attempt to reverse the production hikes and revive the collective OPEC-Russia output curbs.

There is no doubt that both OPEC and Russia have been surprised by the oil markets very negative price response. While Russia only needs around $42/b to balance its budget Saudi Arabia’s is somewhere in the low 80’s.

In the short-term however the attention will turn to U.S. shale oil producers, most of which need higher prices than the current. A February survey covering 87 E&P firms carried out by the Dallas Fed found that all the major shale oil plays need higher prices than the current to breakeven on  new wells.

Instead of congratulating the latest price collapse the U.S. government has appealed for calmer markets. The U.S. has during the past year become a net exporter of crude oil and products and with this in mind a recession in the oil business is unlikely to be off-set by the positive impact of lower prices at the pumps.

The rapid growth in U.S. shale oil production during the past decade has been one of the key developments that at times have caused sharp sell-offs in the oil market. Most recently in August 2014 when Saudi Arabia after months of production restraint off-set rising U.S. production suddenly changed strategy and opened the taps. It took 18 months before OPEC realized that they could not force a reduction in U.S. shale oil production through lower prices.

Since November 2016 when OPEC and Russia got together they have cut production by 4.4 million barrels/day. Primarily through 3.5 million barrels/day involuntary reductions from Venezuela, Iran and recently also Libya. During the same time the rest of the world increased production by 5.7 million barrels/day (source: Goldman Sachs). With demand crashing due to the coronavirus outbreak Russia probably felt that enough was enough and that the continued transfer of market share had to stop. While not being that surprising given the strained U.S. – Russia relationship it was the Saudi Arabia response that triggered Monday’s collapse.

Source: Saxo Bank

These developments have triggered a sharp downgrade in future oil price expectations with some seeing the risk of $20/b oil. Just looking at the current and growing imbalance between supply and demand these forecasts look very valid. But once again we have to remind ourselves that the oil market is probably one of the heaviest political influenced markets in the world. A fact that at any given time makes it very difficult to make any short to medium term price predictions.

Our view is that political interference is likely to prevent the market from falling below $30/b and perhaps we may already have seen the low. The eventual recovery in Brent crude oil back above $50/b is however unlikely to be seen before the second half of 2020. Given the current stock market weakness and rising cost on high yield debt the period up until then should be long enough to inflict sustainable damage to smaller and highly indebted U.S. shale oil producers.

Mind the gap. Brent crude has so far struggled to break yesterday’s high and thereby making some inroad towards closing the massive gab to $45.2/b which opened up over the weekend.

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