Saudi Arabia’s inability to reach agreement over the weekend with a newly intransigent Russia on the scale of OPEC+ production cuts led to a rare “tandem shock” for energy on both the supply and demand sides of the market. With investors, commodity traders, and geopolitical watchers wondering exactly how the OPEC partnership turned so suddenly toxic, and what the lingering economic and political effects might be, Investable Universe turned for wisdom and perspective to longtime oil futures market expert Andrew Lebow.
Lebow is a pioneer in the energy derivatives industry, one of the innovators of the NYMEX WTI crude oil contract in 1983, and is presently a partner at Commodity Research Group, a New York City-area independent research consultancy providing research and general price analysis in base and precious metals and energy products, along with hedging advisory services.
Investable Universe (IU): What do you think is Russia’s endgame in refusing to accede to OPEC price cuts? Is this ruthless or reckless?
Andrew Lebow (AL): The question as to why Russia would go that hard against the Saudis is baffling. The OPEC/OPEC+ partnership was actually working. It may be that the Russians were angry at the Saudis somewhere along the line because the Saudis had made pledges to invest in Russian oil and LNG facilities and they didn’t come through in a big way. Geopolitically, there’s always some backdrop. I think this is really a case of ¿Quién es más macho?
But I’m not sure that the Russians thought that the Saudis were going to go in for this kind of aggressive price war. They (Russia) probably played this wrong as well, and might be taken aback at the moment. If the Russians were prepared—which I’m not sure they were— then their goal may have been to go after the U.S. shale producers, of which both Vladimir Putin and Igor Sechin, the head of (Russian energy company) Rosneft, have been openly critical in the recent past.
Russia is really angry about sanctions on the Nord Stream 2 pipeline through Europe. They’ve also been angry about Venezuelan sanctions. So, from that standpoint, maybe there’s some justification for their play against the U.S.
Basically, Russia is saying to the Saudis, ‘We can withstand $40 oil,’ and the Saudis have responded with, ‘Well, can you withstand $30? Can you withstand $20?’ It’s true that Saudi Arabia is currently the lowest cost crude oil producer by a substantial margin, but it’s unlikely that the added volume will supplant the loss of revenue owing to sharply lower prices.
Both Saudi Arabia and Russia spent this (Tuesday) morning posturing. The Saudis said that they would increase next month’s production to 12.3 million bpd (barrels per day) vs. this month’s 9.7 million bpd. The Russians said they were going to increase by 0.5 million bpd. It’s clearly in neither of their interests to ramp up volume to those kinds of levels. We’ll see if it is anything more than posturing.
Still, Russia may be willing to take some pain and let a protracted price war play out if they can succeed in cutting U.S. production in some significant way.
IU: Speaking of which, how does the immediate future look for U.S. oil and gas producers? We’re guessing not good?
AL: Some companies are facing existential risk right now. You likely won’t see problems in the majors, because their balance sheets are impregnable. An Exxon or a Shell or a Chevron—they’re like countries and some of them are actually better-financed than certain countries. This is not an existential crisis situation for them. But some of the medium-sized to smaller-sized listed independent companies are getting destroyed, and I would say this segment accounts for 5-10% of the total U.S. energy market.
Last time around (during the 2015-2016 oil slump) we lost 1 million barrels per day. Four years later, the majors have a bigger footprint in the Permian Basin, so I don’t think we’ll lose as much as 1 million. We could certainly lose hundreds of thousands of barrels per day of U.S. production—maybe more—depending on the duration of this price war.
There’s going to be industry consolidation. I think they (the major oil producers) will be looking to buy wherever they can increase their economies of scale. They’ve made a big play for the Permian in recent years, so it would likely be there.
But the key thing is that if prices stay down at these levels, U.S. production isn’t going to grow this year and maybe into next year, and in this way the Russians will have had it right. They will have succeeded in stanching U.S. production growth.
But they’re also shooting themselves in the foot. Whereas our overall economy is way more resilient than just what we produce or export, Russia is heavily dependent on fossil fuels. They may cut a few hundred thousand barrels per day out of the U.S energy mix, but at the same time, they’re crushing themselves.
IU: So to what extent is a global energy price war ultimately just a huge China stimulus?
AL: I think it will be a tremendous economic stimulus for China. The only problem is that China doesn’t have enough crude storage as recent numbers place commercial crude storage at record high levels. Therefore they really can’t take advantage [of very low crude prices] yet, unless they want to do floating storage. That’s a real issue for China—otherwise they’d be in there buying with both hands.
If they can figure out how to free up some storage capacity, or put crude in ships—finding ships may be an issue, as well—then maybe they’ll be buying with one hand. But their [refinery] runs are increasing and that will contribute toward freeing up crude storage. It could be beneficial for them, given their buying mandates on the [Phase One] U.S. trade deal. Furthermore it might actually work for them to buy U.S. crude, because the [transport] voyage may allow them to free up some storage or, alternatively, store the barrels at sea. We’ll see if they come through.
IU: And to what extent will lower crude prices actually benefit U.S. consumers?
AL: The big problem is that if we start talking about travel restrictions and quarantines, lower pump prices don’t make any difference if people aren’t driving. If airlines aren’t flying, it doesn’t matter how low the price of jet fuel is.
This is actually a great time for end users—airlines, larger freight companies and shipping companies—to start hedging. This is where they should be stepping in. The difficulty for the airlines is that they have no idea what their loads are going to be. Same for trucking and fleet operators. Nevertheless it would be prudent for end users to at least hedge something during this price rout.
IU: What are the political implications for the (Persian) Gulf region and elsewhere?
AL: The real political implications are likelier to be here in the U.S. The key question is what happens to U.S. oil production if they lead to job losses in the production and service sector. That, of course, is catastrophic for those wage earners. People may be happy with lower gas prices, but it pales when you’re talking job losses, of which there were thousands in the 2015-2016 oil collapse.
The [Trump] Administration will begin to realize that there are political implications, and when they start hearing from representatives from Texas and New Mexico and Colorado and Oklahoma and California—some of them traditionally Red [Republican] states that could suddenly be in play ahead of the election—we’ll somehow have to get involved between the Russians and the Saudis. Using backchannels. Using front channels. It could be much sooner than later, actually. Trump has already had a conversation with Prince Mohammed bin Salman of Saudi Arabia about oil prices.
The thing is, nothing good is going to come from prices down here for Russia or Saudi Arabia, and at some point they’re going to realize this. I’d be very surprised if the price war lasted until November. This is all happening at a time when demand is collapsing, so it’s a very critical situation. Maybe demand will pick up in the second half [of 2020], but that’ll depend on the progress of the [corona]virus. Certainly one of Russia’s goals was to squeeze the U.S. producers, but I don’t think they expected the market to be this low this fast.