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Why Didn’t Russia Just Cut Oil Production?

Published in Oil Industry News on Wednesday, 18 March 2020

Graphic for News Item: Why Didn’t Russia Just Cut Oil Production?

Last week OPEC conducted meetings with a coalition of partners that have worked together to limit oil production since 2016. It was widely reported that the group hoped to come to an agreement to reduce oil production by an additional 1.5 million barrels per day (BPD).

The meetings came in the wake of reports from the IHS Markit Crude Oil Market Service that Q1 2020 world oil demand will decline by 3.8 million BPD from a year earlier. This will represent the largest quarterly demand decline ever reported.

But this time one of the key partners of the coalition, Russia, refused to participate in additional cuts. They had previously signaled their resistance to additional production cuts in February when OPEC floated the idea.

Oil prices plunged by nearly 10% following this surprise move by Russia. It had been widely expected they would go along with the plan, because the alternative seemed much worse. So what exactly are they thinking?

Deja Vu

Let’s rewind back to 2014, when OPEC initially declared war on U.S. shale oil producers. Oil prices had begun to weaken as shale oil production continued to expand, so OPEC decided it needed to act to protect market share. A price war ensued that dropped oil prices all the way into the $20s. At that time I noted that the decision would probably cost OPEC a trillion dollars or more (and it likely did).

While some shale producers were forced into bankruptcy, most were far more resilient than OPEC had imagined. Thus, two years later OPEC waved the white flag and returned to the strategy of making production cuts in order to support prices.

The downside of this strategy for them was that, while these production cuts do help support oil prices, they also keep U.S. shale oil producers in business. So, shale production in the U.S. kept expanding. This put OPEC in the cycle of having to cut production again and again as shale production kept climbing. Many OPEC members deemed this unfair, but they had already experienced the alternative and it was worse.

From Russia’s point of view, all this strategy was doing was propping up U.S. oil producers at the expense of everyone else. The only way this strategy would ultimately work would be for OPEC and its partners to keep cutting until U.S. shale oil production began to decline. Their hope was that this happened sooner rather than later, but in the interim OPEC production fell to a 17-year low.

It’s worth noting that Russia also needs the money from its oil exports. But it is embarking on a potentially expensive gamble in refusing to cooperate with OPEC. They may sell more oil this way, but at a far lower price.

Coronavirus Changes the Equation

But the global coronavirus (COVID-19) outbreak has forced the issue. Now, instead of having to deal with the addition of another million BPD of U.S. shale every year, suddenly they had to cope with millions of barrels of excess oil on the market as demand collapsed in response to the coronavirus outbreak.

So, Russia is effectively revisiting the 2014 strategy of defending market share. Saudi Arabia, in response to Russia’s decision, made the biggest cuts to the price of its crude oil in more than 30 years. Aramco shares, in turn, fell below their IPO price for the first time.

I have written many times that OPEC is in a no-win situation with respect to U.S. shale oil production. The group tried one costly strategy, and then another, and now it is being forced by Russia back to the original strategy.

oil prices could fall much further without Russia’s cooperation in making additional cuts. Now that it is clear that this is the path forward, we are entering an extremely painful period for oil producers everywhere. Oil prices will collapse. Oil producers are going to go bankrupt. Government budgets are going to be drained in oil-exporting countries.

The End Game

It is likely, in my view, that the endpoint will be similar to the last time this strategy was attempted. Oil prices could dip all the way into the $20s. Russia will probably eventually decide that the pain is too great, and come back to the table. In the interim, many shale oil producers will be forced into bankruptcy.

Meanwhile, a bigger existential risk looms for the global oil industry. Electric vehicles (EVs) will continue to gain market share year after year. If we are entering a multiyear oil price war — as seems likely — it is possible that the oil industry never recovers.

That is what can happen when there is a black swan event like coronavirus. The outcome can be beyond imagination. We have entered uncharted waters.

Source: oilprice.com

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OPEC Oil and Gas, OPEC, Global Oil and Gas, Saudi Oil and Gas, Iran Oil and Gas, Russian Oil and Gas, Oil Price Freeze, Oil and Gas News

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