Many of you may have noticed that the price of gasoline has gone down considerably over the last few weeks. Readers may be tempted to believe that the Corona Virus as the cause of the low prices of gasoline. It is part of the reason because of reduced consumption. However, the low price of gasoline is caused by an oil war between Saudi Arabia and Russia.
The Russian-Saudi Arabian oil price war began shortly before the corona pandemic was fully understood. The oil war is not the result of the Corona Virus but, rather it is the geopolitics of oil. Corona is an additional player in the oil war.
OPEC’s place in the oil industry has been to manage the price of oil on the world market. It did so by balancing the supply with the demand to keep oil prices stable. Not all oil producing countries belong to OPEC but many work with it to keep oil prices stable. Russia is such a player. It is not a member of OPEC but has informally agreed to keep prices stable.
Saudi Arabia, the defacto leader of OPEC, and Russia were expected to agree to another price balancing scheme this month and both were gaming the process for a better deal.
Then the Coronavirus came along and global oil consumption dropped significantly.
In March, Saudi Arabia walked away from the oil agreement it had informally with Russia and the oil war began. Saudi Arabia wanted lower oil prices and Russia refused. Saudi Arabia then flooded the oil markets to force Russia to comply.
Saudi Arabia is highly dependent on the price of oil for its national revenues. Oil exports account for 85% of Saudi Arabia’s exports and it is 31% of its GDP. Around 2014, Saudi Arabia began feeling threatened by America’s sudden export of shale oil that forced oil priced down. In response, it began to grow its market share. Saudi Arabia was hoping to force the American shale producers out of business.
Supply and demand drives the price of oil. But oil has a storage capacity problem. There is a limit as to how much oil can be stored. Under normal circumstances, as the oil is taken out of the ground it is delivered to its destinations as quickly as possible.
The more oil that is stored the lower the price per barrel drops.
This is where things get interesting.
The Corona pandemic has reduced the global consumption of oil. Factories have been idled across the globe and cars are being driven less.
Herein lies the geopolitics of oil. Russia has resisted Saudi Arabia’s call to cut production to help stabilize the price, although also intending to keep pressure on the American shale producers. Russia refused and the oil war was unleashed.
But Russia and Saudi Arabia can produce oil at much lower costs and both have the resources to withstand the loss of oil revenues longer than other countries.
The target remains American shale oil producers.
American oil producers have long resisted working with OPEC in stabilizing oil prices. The United States is now the largest oil producer in the world.
Most American shale oil producers are budgeted to operate when oil is at about $55 a barrel. Most lose money when oil drops to $30 a barrel. The exception is Exxon Mobil which can make a profit on its oil from New Mexico at $26.90 per barrel.
But most American oil producers are at risk of going out of business now that the price per barrel of oil is at about $20 a barrel. West Texas was at $20.40 yesterday. Mexican Maya is selling at about $10 a barrel. Many American oil producers have shut down wells and cut back on production.
Shutting off oil wells is not as simple as turning off the oil faucet. Wells are intended to operate continuously. Turning off a well is costly and difficult to reopen. Many times, the shutoff process damages the wells making it more expensive to bring them online again.
But with storage capacity at an all time high, many well operators will have no choice but to shut off the wells, further exacerbating the problem. The economies of Montana, Louisiana, Oklahoma and Texas are particularly vulnerable. The upcoming shale oil calamity will trickle down through the country as bankruptcies trickle through the financial system and job losses mount in both the oil wells and the refineries that depend on the oil.
Saudi Arabia started by trying to drive the American oil producers out of business by increasing production to drive prices down. It then tried to bring Russia on board with a scheme to curtail production to stabilize the price of oil.
In the end, it is likely that the Corona epidemic will be the thing that drives the American oil producers out of business.