• agoldson888

OPEC+ | The Virtual Oil Cartel

The cross-border closings and the potential lethality of Covid-19 forced OPEC+ to conduct a virtual meeting on April 12 similar to the Group of 20 virtual meeting on 26 March. These virtual meetings have set a precedent with organizations at the highest levels during a crisis and may carryover as standard operating procedures for post-pandemic communications.

For OPEC+, like their counterparts, holding a virtual meeting was critical because the Covid-19 pandemic has resulted in the collapse of world economies and subsequently oil demand destruction.

The New Game Changing Virtual Reality

Should OPEC+ adapt this new and effective communications protocol, it will fundamentally change the decision-making process by making them far more proactive rather than reactive to changes in the global oil market. Historically OPEC’s inability to be more proactive has been its Achilles heel whose decisions lag in an ever increasingly fast-moving market. Virtual meetings place them far closer to oil price dynamics.

For this reason virtual communication is particularly useful in a present-day extreme crisis in an environment of low oil prices, low demand, record-setting inventory against the backdrop of the tentative re-opening of world economies.

Virtual meetings provide OPEC+ members a rapid response to schedule emergency meetings within days if not hours. Furthermore these virtual meetings won’t have the logistical encumbrances of travel and time which means its duration can continue well beyond the 72 hours at regular in-person. Nonetheless the application of advanced technological of communications does not signify better business communications or coordination – often it amplifies them.

Whether and to what extent they exercise this new communication option is an open question because for political reasons some OPEC+ members would prefer in-person meetings.

The New Co-Swing Producers

Emerging from the oil demand destruction caused by the global economic lockdowns, the Saudis and Russians have emerged as the new co-swing producers who have achieved their objectives. Whether through design or default, US shale oil firms are in full retreat and disarray with a considerably diminished role as zero demand and rock bottom prices have accelerated the bankruptcies, consolidations and eventual restructurings. Furthermore the diminished US shale oil production provides the Saudis and Russians have a window of opportunity to increase market share, and despite their uneasy alliance. Political and operational cohesiveness is key.

The Russo-Saudi Oil Price Gap

The Saudis require $83/bbl to balance their budget while Russia is satisfied to be in their sweet spot breakeven price of $40/bbl – a canyon-wide difference of $43/bbl.

How? For the Russians there are internal competing interests: oil producers and the government. Oil prices above $40/bbl are by law heavily taxed by the Russian government. This means that $40/bbl is a strongly preferred price point for Russian oil producers; anything above $40/bbl favors Russian government coffers. This price point applies to their aging “brown fields” which have low extraction costs.

The Saudis have increasingly relied on issuing international bonds and the recent modest Aramco IPO to raise funds for Vision 2030 megaprojects. The pandemic has seriously damaged those objectives and more ominously damaged their efforts at meeting basic services to the citizenry, a crisis that if it continues well into 2021 represents an existential threat to the Mohammed bin-Salman leadership.

This is why the huge oil price gap as to what the Saudis require and what the Russian energy firms are satisfied with in the shadow of a global recession exacerbates the never-ending friction between these two countries with respect to OPEC+ production issues.

US Shale Oil Runs Out of Gas

In my article published by Seeking Alpha 19 November 2019 entitled Oil Prices Heading toward A Hard Landing, I discussed in detail how US shale oil firms’ lack of fiscal discipline will shortly drive them into a financial ditch. Under the article’s “Supply – U.S.” sector I noted: “In sum the following USIA chart shows the widening gap between US oil production vs declining oil prices that signals an unsustainable financial trend for many US shale oil firms and a potential a hard landing in oil prices.” One of US shale oil’s largest firms Chesapeake Energy Corporation [NYSE: CHK] is considering bankruptcy.

Oil Price Projections

According to The Financial Times 11 May 2020 article, Saudis Will Make Further Supply Cuts To ‘Encourage’ Peers, the Saudis announced a production cut of an addition 1 million bbls/day in June while the UAE and Kuwait agreed to production cuts of 100,000 bbls/day and 80,000 bbls/day respectively.

With the severe reduction in US shale oil production, I believe that oil prices will meander slowly upwards in an attempt to find the right price point. Because of the overly optimistic forecasts of re-openings that will overshoot the fundamentals, oil prices will probably be slightly over-valued during its ascent. Furthermore, upward pricing will have traction issues because of the historical massive inventory glut.

In sum I project that oil prices will reach $40/bbl by Labor Day as global economies gradually recover.

Virtual Reality and Its Impact On Investors

For the long-term investor OPEC+ mobility will have little impact on investment strategies because of the long view that relies more on fundamentals.

Short-term investors must develop a new mindset because OPEC+ has the potential to be more nimble and more pro-active enabling them to shift directions rapidly - from the captain of a super-carrier to that of a speedboat.

Recommendation

I am cautiously bullish on oil prices for the short-term until the Labor Day weekend because of the gradual re-opening of world economies in the midst of the driving season as well as the limited opening of the travel & hospitality industry. For this reason I recommend a broad-based index in which to invest such as the S&P Global Oil Index (CNY).


[Originally published 13 May 2020].


Copyright 2020 Cerulean Council LLC

The Cerulean Council is a NYC-based think-tank that provides prescient, beyond-the-horizon, contrarian perspectives and risk assessments on geopolitical dynamics and global urban security.

Recent Posts

See All