OPEC Strategy – May help aftershocks of COVID-19

In a tug of war, Russia decided not to collaborate this time with OPEC in cutting oil production. Consequently, OPEC contrary to their traditional weapon of cutting oil production, Saudis decided to utilize their excess capacity to enhance oil production. In this way Saudis wanted to destabilize the oil market targeting the booming US shale oil industry. The sensitive market reacted immediately resulting in collapse of WTI to around $31.13/bbl on March 9 from a high of $47.18/bbl on March 3, though prices further dip to 22.84/bbl by March 18, 2020.

Wrong Market Assessment & Wrong Timings

OPEC like others failed to correctly assess the implications of COVID-19 on global oil market, which is alarming and spreading rapidly across the world. This pandemic is already affecting the global oil demand as people are scared to travel and unnecessarily leave their homes. Schools are closed and a number of companies are asking their employees to work remotely from home -- very thin traffic even during peak hours. In Italy, all restaurants and shops are closed with the exception of pharmacies and supermarkets. A number of European countries are complete to partial lock-down. While other countries also weighing such an option of complete lockdown in an effort to restrict wide spread of COVID-19. Like so many countries that already have stopped their airlines flying to most of the affected countries, US President Trump on March 11, 2020, put a 30 days travel ban from European countries. This news further reduced oil prices and oil demand. If such a situation persists for an extended period of time then surely one could see a large number of bankruptcies in aviation and oil industry as well as collapse of the global economy.

Have we Learned Lessons from History? 

A similar strategy was adopted by OPEC in 2014/15, after the collapse of oil prices, but it was unsuccessful (Figure-1). In response to decline in oil prices, the US shale oil production down from peak of 5.95 mmbd in March 2015 to 5.11 mmbd in September 2016, a lag of 8-10 months or in some basins even more lags are involved. However, once oil prices increase to fifty, US shale oil production increased (for more statistical analysis please read “Will OPEC Use This Strategy To Defeat U.S. Shale?”).  At the end of Feb 2020, US shale oil production reached 9.16 mmbd despite average WTI was hovering in fifties.

No doubt, this strategy will affect all OPEC and non-OPEC oil producers but the intensity would be quite different. In contrast, US shale oil producer’s survival depends on how long such strategy Saudis prolonged and US government supports.  Unlike in the past, this time US government prepared to shoulder the shale oil industry. In fact, US government already decided to buy 77 million barrels for strategic petroleum reserves (SPR), a move to insulate US shale oil producers from possible bankruptcies. U.S. government will do the needful to ensure that shale oil industry remain successful and continue to play important role in US economy. Because of shale industry US was able to reduce its oil import dependency from over 60% to below 25%. My assessment is that one call from US president will reversed their decision and oil prices will bounced back to over $35/bbl instantly irrespective of surplus.

Self-inflicting Damage

Saudis are not only losing oil revenues due to lower oil prices but also due to lavish discounts to capture market share.  In addition, to avoid wide spread of COVID-19 the government put a ban on Umrah (pilgrimage). Consequently, it adversely affecting their hotel/tourism industry and economic activities as millions of people who spend million on goods and services during their stay is lost. The government that requires a price tag of over $80/bbl to balance its budget has no options to withdraw huge resources from sovereign funds to keep their economy afloat. Saudis have this liberty but it would have devastating impact on other fellow OPEC members and non-OPEC oil producers. 

Figure-1: US Shale oil production in comparison to WTI

Unpopular Strategy - Blessings

Quite unaware of such action by Saudis, it turned out to be blessing for the global economy and surely provided some breathing space to recover from the aftershocks of COVID-19. Savings out of reduced oil import bill would be spent to fight against the COVID-19 that requires enormous resources anyway. Sometimes, unusual out of box decisions turn out to be blessings - thanks to Saudis for timely gift to mankind. 

* Dr. Salman Ghouri is an independent energy consultant.