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An alliance between Saudi Arabia and Russia that has helped to prop up world oil prices for the past three years has collapsed, threatening to send the market into freefall.
The breakup comes at a time when oil demand is already severely weakened by the economic of the coronavirus outbreak. Prices have already declined by more than 25% since the start of the year, with benchmark Brent crude trading around $45 a barrel on Friday.
If the Saudis and Russians start to pump more in an attempt to protect their market share, prices could fall to $30 or below, say energy industry analysts.
Ministers of the Organization of Petroleum Exporting countries and their allies — known as OPEC+ — left a fractious meeting in Vienna on Friday afternoon with no deal to continue restraining their output. That raises the specter of a price war at a time when the industry can least afford it.
“This is going to get nasty,” said Doug King, a hedge fund investor who co-founded the Merchant Commodity Fund. “OPEC+ is going to pump more, and the world is facing a demand shock. $30 oil is possible.”
The market reaction on Friday was as vicious as it was swift. Brent crude prices fell 9.4%, the most since the global financial crisis in 2008. The spiral may not be over. Previous collapses in cooperation between OPEC nations since 1960 have triggered punishing slumps that shaped the industry for years.
“This is an epic fail,” said Bob McNally, founder of Rapidan Energy Advisers.
The fate of the meeting was sealed when Saudi Arabia and other members of Opec threw down a gauntlet on Thursday, proposing an additional production cut of 1.5 million barrels per day (bpd) for the rest of this year — but only if Russia would join. Moscow, which had been arguing for less drastic action, held firm.
The meeting exposed a fundamental disagreement between Russia and Saudi Arabia, previously so close that their relationship was recently described as a marriage. Moscow was content that the virus-induced drop in demand would push prices lower, a body blow to the US shale industry. Saudi Arabia, where the economy is less adaptable to low prices, disagreed.
There may still be time for reconciliation. OPEC nations said the door was open to further talks.
“We need to give Russia some more time and hopefully they’ll come back,” said Suhail Al Mazrouei, the energy minister of the United Arab Emirates.
But there didn’t seem to be much indication of that from Russia’s Alexander Novak, who left the meeting saying there would be “no obligations to cut output” from April 1.
That suggests Saudi Arabia and Russia could be about to drop all production restraints, reversing a 2017 deal between the two countries.
Asked how Riyadh would respond, Energy Minister Prince Abdulaziz bin Salman said, “I will keep you wondering.” His country can, on short notice, add 2 million bpd. Others, like the UAE and Kuwait, can pump a few hundred thousand barrels more a day.
Then there’s Russia, whose state-owned oil company Rosneft has been chafing under the constraints of the 2017 deal since it began. It could lift output by 300,000 bpd within weeks, according to analysts.
The situation has a few precedents in OPEC’s 60-year history, and none of them are pretty.
In 1985, Saudi Arabia, after years of shouldering OPEC production cuts nearly by itself, gave up and launched a price war. Prices collapsed almost 70% between November 1985 and May 1986.
The kingdom crashed the market again in 1997, its patience worn thin by overproduction in Venezuela. In the next year and a half, prices fell 50%.
And in 2014, Saudi launched a price war after it failed to convince non-OPEC countries, including Russia, to join in an output cutback. Prices declined 65% over the next six months.
But none of those previous scenarios took place while demand was going through a brutal contraction, much less one triggered by the worldwide spread of a deadly virus. On Friday, Redburn, a market research firm, sketched out a scenario in which demand collapses this year by 1.5 million bpd, the biggest drop since 1982.
For OPEC, the closest historical parallel is 1997. At a meeting in Jakarta, Saudi Arabia decided to boost production just as demand slumped due to the Asian economic crisis. Prices dropped to less than $10 a barrel, triggering a pitiless industry shakeout.
If OPEC and its allies can’t agree on some form of supply management, the fallout promises to cause economic chaos in some oil-dependent nations and a wave of producer bankruptcies.
Oil traders are looking to historical charts for an indication of how low prices could go. One potential target is $27.10 a barrel, reached in 2016 during the last price war. But some believe the market could go even lower.
“We’re likely to see the lowest oil prices of the last 20 years in the next quarter,” said Roger Diwan, an oil analyst at consultant IHS Markit and a veteran OPEC watcher, implying that the price could fall below $20.
Even at current prices, many drillers aren’t turning a profit. But they may not stop producing immediately. Until they can no longer make enough cash to cover their day-to-day expenses, they’re likely to keep pumping. In 2016, it was only after oil fell below $30 a barrel that some of them began to idle their wells.
The most immediate pain is likely to be felt in the US shale industry, where companies have already been struggling as investors lost enthusiasm for the sector. In part, that’s what the Russian energy ministry has been aiming for.
Still, the hurt is likely to be spread much more widely across the world, from commodity-dependent countries like Angola and Oman, to energy giants like Exxon Mobil and Royal Dutch Shell.
It will also make life more complicated for companies like BP that are trying to reinvent themselves as greener producers. Cheap oil will compete against renewable energy, potentially putting a drag on the rise of electric-vehicle companies.
The first indication of Riyadh’s next move will likely come later on Saturday, when Saudi Aramco is set to publish its official crude selling prices. A deep price cut would signal it plans to ramp up production after the Vienna failure.
“The reckoning has come,” said Dan Pickering, a veteran Houston-based energy banker. “Oil has a supply problem, a demand problem and an OPEC problem. We’ve seen this movie in 2014-15-16. It doesn’t end well.”
