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Politics in the oil market means volatility will continue

A battle for dominance in the oil markets of the future has been raging between Riyadh, Moscow and Washington, as moves towards cleaner-energy production gather pace.

A battle for dominance in the oil markets of the future has been raging between Riyadh, Moscow and Washington, as moves towards cleaner-energy production gather pace.
Garry white employee

Garry White


The recent recovery in crude prices is not guaranteed to continue. In fact, oil prices could go much lower in the next few weeks as the global glut of oil grows, because politics in oil markets has become increasingly fraught.

Extracting oil in America is expensive, compared with the low costs seen in Saudi Arabia and Russia. The US’s energy independence has been driven by the shale revolution, but this is technically more challenging, resulting in higher costs. Estimates of the cost shale extraction vary wildly, but the industry claims be profitable at about $50 a barrel.

But the US oil price fell below $20 at the start of last week, prompting a worried Donald Trump to act. If prices stay at this level, many US shale-oil producers will go bust – with Whiting Petroleum becoming the first casualty on Wednesday last week.

Permanently low prices would also shatter the US core strategic aim of energy independence, as well as causing a crisis in bond markets. A significant chunk of higher-yielding, riskier corporate debt issued in by American businesses is by shale operators that were spurred on by the Republican Party’s mantra to ‘drill, baby. Drill’.

So, Donald Trump took to his Twitter and succeeded in putting a rocket under oil prices, which soared by around a third. The president assured the world that the Russians and Saudis would slash production – but it is often a mistake to speak for somebody else.

Typical Trump

Last week’s social-media utterances were classic Trump. After having some success in talking up falling stock markets via Twitter during trade talks – a move that became known as the ‘Trump put’ – he is trying the same tactics in oil markets. But Washington hawks play no part in Opec+’s decision and both Riyadh and Moscow have much to gain over the longer term by keeping prices down. America has much to lose.

Speculation of a “virtual” meeting of Opec members with Russian representatives this week added to the euphoria. But this could be no reason to celebrate. After all, it was disagreement at the last meeting at the start of March that accelerated falls in equities and oil.

Saudi Arabia’s de facto leader, Crown Prince Mohammed bin Salman (MBS), has been trying to diversify the Saudi economy and attract new investors. But the murder of journalist Jamal Khashoggi and the bloody war in Yemen caused global investors to balk, turning MBS’s ambitious plans to dust. The flotation of state-owned oil group Aramco – the most profitable company in the world – was shunned by western money managers and it had to abandon plans to list in New York or London. Riyadh was dealing with an existential crisis even before the emergence of Covid-19.

Frustration led to flood

Since 2016, Saudi Arabia has been supporting oil prices by cutting the amount of crude it sells in global markets. The Saudis were keener on the cuts than their Opec peers because MBS wanted Aramco’s to secure the highest valuation possible at its IPO.

But Saudi frustration that it was making most of the sacrifices in Opec – and losing market share as a result – has now boiled over. The American shale industry, which propelled the US into the world’s top producer spot in 2018, continued to pump crude unabated. Many Opec members also ignored their reduced quotas set by the cartel.

Russia’s refusal to reduce its own output to deal with the Covid-19 demand slump was the final straw for MBS – and the Saudis now want their market share back. So, Saudi Arabia is flooding oil markets and discounting prices to steal its rivals’ business.

In a commodity price war, the cheapest producer always wins if it can hang on until the rest have gone bust. Saudi Arabia has always occupied the position as the world’s cheapest producer of crude because of its unique geology, but Riyadh shouldn’t be too smug. Russia is probably in a better position to ride out low prices than the Saudis.

Moscow looks strong

Oil exports are an important component of the Russian economy, but roughly two-thirds of its economy is in services, and it is rich in other commodities such as platinum, diamonds and nickel. The coronavirus crisis has also sent the dollar soaring – and the Saudi riyal has a dollar peg. Helpfully for Mr Putin, the rouble is not tied to the US currency. This means its costs of production is falling sharply in local currency terms, acting as a significant economic cushion. Some have even suggested that Russia is now producing oil cheaper than the Saudis.

Global oil storage facilities are almost full – and the Covid-19 crisis is accelerating. Even if this week’s oil-producer meeting agrees a collective cut of 10 million barrels a day (bpd), global oil inventories would still rise by 15 million bpd in the second quarter, according to the International Energy Agency.

Right now, Donald Trump is basking in his ability to move the oil price but, ultimately, things may not turn out quite like he’d hoped. Oil at $10 may sound extreme – but given the severe circumstances, it really cannot be ruled out.

A version of this article appeared in Monday’s Daily Telegraph.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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