Plummeting Oil Prices – A Triangular Contest

Over the weekend, shocks were transmitted all across the globe from Vienna as oil prices posted a dramatic decline of over 20%, following the cartel meeting. This downturn in the global oil prices came on the back of OPEC+ meeting which was organized in order to counter the ramifications of COVID – 19 (Coronavirus disease). However, the meeting turned out to be an endpoint of over three years old marriage between Saudi - dominated OPEC and Allies (primarily Russia).

A decade ago, China was growing at a robust rate, resulting in increased demand, leading to build-up in crude prices. From 2011 to 2014, per barrel Brent crude oil prices largely stayed in triple digits and USD 100/barrel was considered as an equilibrium price. From 2014, the downward cycle of the commodity started owing to higher Shale output in United States. Saudis had then exploited the global energy landscape by loosening their taps; causing glut. This glut eventually translated as sharp decline in international oil prices which bottom out in January 2016 around USD 30 per barrel. In that episode, the Saudi motivation seemed to be driven by maintenance of their market share, as the tight oil (Shale) could not be feasible below USD 50 per barrel compared to a single digit per barrel feasibility of crude oil output in the Gulf region.

Nevertheless, the Saudis along with Russia faced the brunt as both economies are heavily reliant upon the commodity. In that context, OPEC and Russia collude with each other in late 2016 in order to do combined efforts for tightening oil supplies. Uptill October 2018, oil prices gradually firmed up to USD 85 per barrel from a price level of around USD 40 per barrel, at the time of start of this alliance. On the other hand, slowdown in world economy in the wake of slowing China and early signs of trade spat between United States and China started undermining the OPEC+ efforts to support prices. While OPEC and its allies were religiously following the supply cuts, United Sates was continuously surging its Shale output by increasing rig count. This Shale output helped United States in becoming world largest commodity producer, surpassing Saudi Arabia and Russia.

In this backdrop, Russians decided to go beyond OPEC+ supply cut deal last weekend, provoking Saudis to initiate a price war - a turf - well known to them since Yom e Kippur War (1973). Immediately, after the breakdown, Saudi Arab announced to increase its output from 9 million barrels a day to 12.3 million barrels a day by April 1. Furthermore, they showed their intention to execute further CAPEX for enhancing oil production to 13 million barrels a day. Currently, Brent is hovering in the band of USD 30 – 40 per barrel. Such a price level would almost make Shale production infeasible given persistence level of higher leverage in the industry. Even the recent 50 bps cut in FED policy rate would be insufficient to create a space for tight oil. Interestingly, by and large, the analyst fraternity believes that oil prices have not bottomed out yet, rather they are in a cascade.

Warren Buffet, termed the current situation as big one-two punch, as this oil price crash is coupling with outbreak of coronavirus. Though historically, lower oil prices have had added stimulus to consumer spending and (non-oil) industrial production, the spread of the fatal virus is likely to taper the global growth outlook. People, globally are abiding themselves from travelling and other leisure activities. Governments are becoming more and more prudent in scrutinizing the entry points of their respective territories; airlines are closing operations. Accounting for the current situation, the demand of crude oil is not expected to recover unless, the COVID -19 virus get overpowered. Nonetheless, the crude stock piles are also rising rapidly, and none of the players are showing any signals for output cut in future.  Overall, this bloodbath in crude oil prices can be treated as another impediment in the recovery of world economy.   

Coming to the implications of this oil price saga on Pakistan economy, it is widely conceived as positive development given almost one-fourth share of petroleum products in total national imports. Thus, this downtick is expected to support foreign exchange reserves of the country. Moreover, the downtrend will facilitate the government in extracting higher levies which would be instrumental in managing the fiscal side of the economy. However, on the flip side, the global slowdown is likely to impart a negative impact on the country’s exports and workers’ remittances. In view of higher volume of imports in the current account, the recent oil supply shock bodes well for external indicators like CA deficit as a % of GDP and the stability in exchange rates.

Syed Monis Jawed