Decoding the uncertainty in the global oil market

The Saudi-Russia battle is shaping prices for now. But other factors will play a key role in the medium-term

Pinning down the price of crude oil has become a complex task with an unprecedented numbers of slippery variables, even as its desirability in running the global economic engine is being increasingly questioned.

The Organisation of Petroleum Exporting Countries (Opec)+ cartel meeting held recently in Vienna witnessed a dramatic fallout between Saudi Arabia and its one time ally, Russia, over slashing output to offset the huge cratering global demand. This escalated into an unprecedented oil war for grabbing market share between two of the world’s largest oil producers. Riyadh has vowed to flat out pump 12.3 mb/d, and has offered deep discounts to its buyers, while Moscow has said it will open its spigots unconstrained by the current Opec pact — thus flooding an already oversupplied market. Earlier this week, oil prices saw the biggest drop since the 1991 Gulf War.

Moscow’s reluctance to join the Saudiled Opec’s proposal of deeper cuts is ostensibly to jolt the shale industry, which has catapulted the United States (US) as the world’s largest oil producer. The recent sanctions on Rosneft Trading and the consequent halting of NordStream 2 — an ambitious pipeline project that would have connected the Siberian oil fields with Germany — are other America-inflicted geopolitical measures that have irked Moscow.

All eyes are now on whether the oil cartel’s warring parties wade back to the negotiating table. However, crude prices in the medium-term will be significantly determined by four factors, some of which lie beyond the influence of the unwieldy Opec+ alliance.

The biggest dampener in global demand is the novel coronavirus that has ravaged supply lines, tourism and travel, and quarantined millions. Radiating from its epicentre in Wuhan, China, it has infected South Korea, Italy, the US and Iran, among others. World oil demand is set to fall for the first time since 2009 with the International Energy Agency downwardly revising its demand estimates by one mb/d, given a combination of significant demand shock and massive supply overhang.

Though these are early days to predict the trajectory of the Covid-19 and its duration, with the virus peaking in parts of the world and waning in others, regardless, this will have a major sputtering effect on the global economy at least for this year.

Russia’s gamble to hollow out the US shale industry is just that — a gamble, which may boomerang. The American shale landscape comprises a heterogeneous mix of break-even producers and ones with stronger balance sheets. There are producers who may be able to hold out at $30 a barrel, but if prices continue at current levels over an appreciable period, the closing of rigs, bankruptcies, job losses and capital flight would significantly damage one of America’s most fortune-changing products.

However, the obituary of the US shale industry has been written before — in the aftermath of the 2014 oil price collapse. But the industry is now in a better space to weather an oil war. And like in 2014, it may end up consolidating the larger companies and weeding out the weaker ones, thus hiking production efficiency.

The future of shale is also dependent on the outcome of the American elections — both Bernie Sanders and Joe Biden have either spoken of bans on hydraulic fracking or stricter regulations around it. Donald Trump, on the other hand, plans to double oil production at the Permian Basin. The “energy independence” of the US has been one of the biggest gamechangers in recent times for pegging crude prices and has triggered the reshaping of geopolitics. The outcome of the oil war visà-vis shale and future policy decisions will determine US’ energy dominance.

Additionally, for a medium-term assessment of the global energy sector, the overall impact on renewables given the current scenario of plunging oil prices has to be factored in.

The climate crisis narratives that have come to occupy political centrestage of advanced economies will only gain traction. This is most starkly evident by big companies such as the Rockefeller nonprofits, which have made their fortune traditionally through the oil and gas sector, now trying to shift away association with it.

Another factor will be the dynamics of the US-China trade war, which has been playing out for almost two years. The world’s two largest economies have been locked in a bitter trade battle inflicting billions of dollars of tariffs on each other. Crude prices in the middle term will also be impacted by how much global demand is delinked from this trade war.

Finally, the repercussions in the region in the wake of the assassination of Iranian commander Qassem Soleimani have not been fully realised yet. The Islamic State is still present in Iraq, while the US is dismantling its aid scaffolding to the war-torn country that is meant to stave off the dreaded terrorist group.

The lull in retaliation on Tehran’s part may also come from the impending American and Iranian elections. Major demand centres, like India, have turned to Iraq to quench their thirst for fuel in the aftermath of the Iran sanctions. Any disruption in the southern Iraqi pipelines could throw oil price dynamics into even more unpredictable territory.

Crude prices will be determined by global factors, thus limiting Opec+’s power even if the alliance pulls through the present existential crisis.