A Crude-Awakening: The COVID-19 Oil Price War

Ironically, the rapid price decline followed from a meeting of the Organisation of Petroleum Exporting Countries (OPEC) where the goal was to reduce oil production so as to offset the collapse in demand, due to the COVID-19 outbreak, and in doing so stabilize and support the oil price. Saudi Arabia’s push for steeper and longer production cuts than had been expected by OPEC members, and Russia’s refusal to decrease its production to this extent, resulted in a deadlock. Analysts reported that Russia had become increasingly frustrated with OPEC’s policy of supply restraint. Russia views this as facilitating the growth of shale oil producers in the United States. Recently sanctioned Russian state-owned oil company, Rosneft, stated that “by yielding [their] own markets, [they] remove cheap Arab and Russian oil to clear a place for expensive US shale oil and ensure the effectiveness of its production”. Immediately after the failed OPEC meeting, Saudi Arabia, ramped up its oil production, slashed crude oil prices for its preferred customers and plummeted the oil price.

By launching an oil price war, Russia and Saudi Arabia engaged in a high-stakes game of “who blinks first”. In the meantime, the oil market would re-balance itself largely at the expense of the United States shale oil producers. This of course did not sit well with the United States, which is regarded as the “most important ally to Saudi Arabia”. Senators in the United States called on the Trump Administration to implement the No Oil Producing and Exporting Cartels Bill (NOPEC Bill). In summary the NOPEC Bill, in its current form, makes it illegal to artificially cap oil and gas production or to set prices, as OPEC currently does. The NOPEC Bill was last threatened by the United States in October 2018 but Saudi Arabia enabled the oil price to remain above the key US$70 per barrel level. Any sustained oil price above US$70 per barrel is regarded as beneficial to shale producers in the United States. Analysts predicted that the oil price war was likely to last until the end of 2020. The current OPEC production cut deal expired on 31 March 2020 and this would either see a fierce battle for market share, as OPEC members would then be able to produce as much as they please or, optimistically, sanity would prevail between the oil producing giants and a production cut deal would be re-visited.

Ultimately neither Russia nor Saudi Arabia could afford to burn their cash reserves at the rate they were, coupled with the downturn in global financial markets due to the COVID-19 virus. In basic oil economics terms, Russia has a budget breakeven price of US$40 per barrel and Saudi’s is US$84 per barrel. The oil price currently hovers around US$26-US$29 per barrel so this was not sustainable in the long term. It would have been an unwinnable war for both countries, if protracted.

Following days of discussions, OPEC and its oil producing allies finalised a historic agreement to cut production by 9,7 million barrels per day, starting on 1 May 2020. This is the single largest output cut in history. The agreement ends the Saudi Arabian-Russian oil price war that broke out at the beginning of March. However, despite the record size of the production cut, some fear it’s still not large enough to combat the drop in demand but the agreement  will at least offer a temporary relief for the energy industry and the global economy. OPEC will meet again on 10 June 2020, via videoconference, to determine further actions which may be necessary to balance the market.

It is not the first time the oil price has fallen as dramatically as it did, and it certainly will not be the last. Oil is a resilient commodity and global reliance on it has not tired since the oil economy emerged in the 19^th century. Manufacturing of well over six thousand products are derived from crude oil production and its refining process and on a global scale the primary energy consumption derived from oil and gas is approximately 373% more than global energy consumption from wind, solar and other renewables combined.

In frontier jurisdictions in sub-Sahara Africa, such as Namibia and South Africa, upstream regulatory authorities will need to work closely with oil companies so as to ensure that these investors are able to continue their investment in these non-producing jurisdictions, notwithstanding the drop in global demand caused by the COVID-19 virus and crippling oil price. To this extent regulatory authorities may need to consider allowing oil companies the opportunity to defer work program activities until such time as time as the world has come to grips with the COVID-19 virus and the oil price settles.

The CDH oil and gas team have an abundance of experience in the upstream oil and gas sector in both Namibia and South Africa and with upcoming wells planned in both these jurisdictions regulatory certainty and a good fiscal package for upstream investors is now more important than it has ever been.