Podcast - Opec and US shale: the latest coronavirus casualties | Episode 3

Author Alejandro Babarjosa, Vice-President, Crude, Middle East and Asia-Pacific

Oil prices have posted their biggest drop in almost three decades towards $30/bl on expectations that an Opec-induced supply surge will exacerbate a global surplus, as demand growth collapses beyond Asia with the spread of the coronavirus to most major economies.

The unravelling of co-operation between Opec and Russia to restrain oil output also throws the US shale sector and other non-conventional oil basins into their deepest crisis since at least 2015, as plummeting crude prices jeopardise higher cost projects from Canada to Brazil.

Coronavirus trickles down global oil markets – Episode 2

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Hello everyone, I am Alejandro Barbajosa, Vice President for crude in Asia-Pacific and the Middle East at Argus, and I would like to welcome you all to the third episode of our coronavirus podcast series, where we discuss the impact of the epidemic on global oil markets. Today, we will address how OPEC and US shale are set to become the latest victims of the epidemic.

The battle for market share in the global oil industry is back with a vengeance. After more than three years of co-operation between OPEC and non-OPEC partners to successfully support the price of oil mostly above $50/bl, Ice Brent collapsed by as much as $14/bl on 9 March, the biggest drop in almost three decades, towards $31/bl, the lowest intraday price in more than four years. Nymex WTI touched $30/bl after Russia declined to participate in a new stage of production cuts proposed during last week’s Opec meeting to counter the expanding negative effect of the coronavirus epidemic on global oil demand. Opec producers led by Saudi Arabia had pledged to cut an additional 1mn b/d contingent on cuts of 500,000 b/d by their non-Opec partners, led by Russia. Moscow’s refusal to join the new cuts was the straw that broke the camel’s back, leading the Saudis to completely abandon any price management efforts and aggressively reduce official selling prices for term crude customers, to recover market share lost mainly to US producers over the past three years, particularly in Asia-Pacific.

Saudi Aramco over the weekend announced record price cuts for all of the kingdom’s export grades to term customers across every region. Taking Arab Light as a benchmark for Saudi official selling prices (OSPs), the reduction for Asian clients was of an unprecedented $6/bl, about three times the decline that would have been justified by the shift in the Dubai market structure from the previous month. The demand drop resulting from the coronavirus epidemic sent the premium of front-month Dubai swaps relative to the third-month contract from more than $2/bl on average in January to a small discount by the end of February, flipping the structure from backwardation into contango. Aramco’s bigger-than-expected OSP reduction left Arab Light at a $3.10/bl discount to the average of the Oman-Dubai benchmark, the deepest discount since Argus records began in 1996.

With no additional Opec cuts, Argus Consulting expected stock builds of about 750,000 b/d in the second and third quarters of 2020 including an increase in Libyan crude production towards 1mn b/d. But after the unravelling of the Opec+ partnership, Saudi output is likely to increase from 9.7mn b/d to 11mn b/d, plus at least another 200,000 b/d from other Opec producers, translating into additional output of 1.5mn b/d from Opec. This means the stock build should exceed 2mn b/d over the course of the second and third quarters of this year. All this still assumes that oil demand grows by 500,000 b/d in 2020, but that looks increasingly doubtful as major economies suffer the strain of the epidemic. In the absence of demand growth, we could see inventory accumulation of close to 3mn b/d until the end of the summer, when we could start to get some material impact from lower prices on US shale production.

Argus Consulting was expecting non-Opec supply to increase by more than 2mn b/d this year, but a crude price environment of between $30 and $35/bl for a sustained period will undoubtedly undermine the ability of high-cost non-conventional oil to keep growing. In fact, Goldman Sachs is now forecasting $30 for Brent in the second and third quarters, so some of the most expensive basins in the US shale patch are likely to post a sharp deceleration or even a contraction in output, especially after some production hedges lapse after six months. While the Permian basin may still show some growth even in this dramatically lower price environment, output at the Eagle Ford and the Bakken will most likely go into reverse gear in coming months before any decline in production costs associated with a slowdown in drilling rates permeates through to the wellhead.

Over the past three years, US crude exports to Asia-Pacific have increased by about 500,000 b/d per year, Argus data shows, compared to a net decline in exports from the Middle East. The reversal of Opec’s output strategy is bound to bring an abrupt halt to this trend. This means that the terms of trade for US crude into the Asian market are likely to deteriorate, as refiners from China, South Korea, Japan and southeast Asia maximise their intake of Middle Eastern crude, based on the appeal of extremely competitive pricing. This will make it even more challenging for China to cover the energy purchases required to meet the amounts established by the phase one trade agreement between Beijing and Washington, and will force Atlantic basin crude into storage as the market develops deeper contangos, or discounts for prompt crude relative to supplies for future delivery.

Even before Opec’s policy shift, US crude cargoes were already being sent into storage across southeast Asia as refineries in China, South Korea and other major consumers reduce processing rates in the wake of the epidemic. The first US crude shipment to China wasn’t expected to load until April as ongoing travel restrictions dent transport fuel consumption across Asia. But the double whammy of a coronavirus-induced demand shock and an OPEC-induced supply shock to the global oil market now raises longer-term questions about whether US crude will continue to expand its footprint in markets East of Suez. And in terms of wealth generation, it jeopardises the budget requirements of all major producers including Saudi Arabia, Russia, and Texan shale oil corporations. As Aramco shares trade below IPO levels for the first time, every major international oil company is under pressure.

As I have mentioned before, you can access more timely news and analysis on this topic through our Argus Crude market services and we also have a special page dedicated to the effects of coronavirus across all commodity markets on our Argus website at www.argusmedia.com/coronavirus. Thank you for listening and goodbye!