On 9 March, the oil market saw a big tumble when crude oil prices lost as much as a third of their value, with Brent crude valued at $33.93/MT, while WTI was down by 26.8% at $30.22/MT. It was the largest daily rout since the 1991 Gulf War.
The price drop was a result of OPEC and its allies including Russia failing to agree on extending and deepening the output cut which expires at the end of this month.
According to Refinitiv Oil Research, Saudi Arabia, Russia and USA together contribute more than 30 per cent of global oil supply and in terms of exports while Saudi Arabia and Russia have had significant control on the market, USA backed by growing shale oil production has seen a surge in exports.
In 2019, USA exported on an average 24 per cent of every barrel of oil produced. Russia on the other hand, exports on an average 40 per cent of its total crude oil production. Saudi Arabian seaborne exports have typically ranged around 70 per cent of production although the export ratio since 2015 has ranged from a minimum of 61% to a max of 78% of production volumes.
The reliance on oil exports and the resultant income is significant for Saudi and Russia. Following Russia’s decision to not participate in further supply cuts, Saudi Arabia has been reported to have announced to increase their production beyond 10 million bpd for the month of April with a possibility to touch 11 million bpd. With the ensuing battle for opening up the cap on production, other key OPEC producers who have been limited by the quotas and compliance over the past three years are also likely to increase production and cut prices in a bid to maintain market share.
Peter Kiernan, Lead Analyst, Energy, at The Economist Intelligence Unit (The EIU) said the inability of OPEC and Russia to reach an agreement on production was a huge disappointment for oil markets, which has only been made worse by Saudi Arabia’s subsequent decision to offer discounts to its oil buyers and increase output.
“Markets were already anxious about the impact of COVID-19 on the global economy, and have reacted negatively at the prospect of a war for market share between the world’s major oil producers in an environment where oil demand shows severe signs of weakness.”
Mr Kiernan said a sustained drop in oil prices also has broader implications. Many US shale producers will face intense pressure to rein in production growth now that OPEC/Russia efforts to shore up prices has ended, while exporters heavily dependent on oil revenue for fiscal health will face very testing times.
“OPEC and Russia might eventually reconsider efforts to cut output if prices stay intolerably low, but for now prices are being left to fall where they may. Some oil-importing economies may benefit from this, but overall this will still be overshadowed by deteriorating global economic conditions.”
Effects on the gas industry
With the global benchmark for oil tumbling, the effect on Australian oil and gas stocks was immediate and profound with stocks crashing between 18% and 35%.
Bruce Robertson, gas/LNG analyst with the Institute for Energy Economic and Financial Analysis (IEEFA) says the reaction of the markets would tend to suggest the impacts of the oil price weakness will not be short lived.
“Global oil prices have a profound effect on gas prices,” says Robertson. “Australia’s export gas prices have effectively collapsed.
Gas sets the price for electricity in Australia’s national electricity market, as gas is the highest cost producer of power and therefore is the last player into the market. Essentially lower gas prices have an immediate effect on the electricity price.
“The solution to the gas price problem that Australian gas consumers face is for governments to call for more gas to be produced,” says Robertson.
“The current project being considered for approval is the locally unpopular Narrabri gas project.
“This ill-fated venture is a high cost gas field where, if developed, it would struggle to supply Sydney with gas at much less than $9-10/GJ.
“This is clearly a globally uncompetitive price for gas. The Narrabri gas project is not economic in a world where gas prices are low and will remain so for the foreseeable future.”
Roberston says the big question to arise out of the oil price crash is will the NSW and Federal governments continue to look inwards and take advice from their donors in the gas industry, or will they make approval decisions for new projects in a global context of low gas prices?
Australian export implications
Australia exports around three quarters of the gas that it produces. Long term export prices for gas are set as a percentage of the oil price. The oil price effectively sets the gas price for export contracts.
Robertson says customers in Asia will be looking at getting their gas at $7.12/GJ under long term contracts if oil prices stay at current levels.
“In Australia, the gas industry is able to charge domestic customers a premium to offshore markets as compliant politicians allow gas companies to run roughshod over the Australian consumer of gas,” says Robertson.
The ACCC has estimated that for every $1/GJ reduction in the price of gas the wholesale price of electricity falls by $11/MWh.
Currently in Australia customers seeking long term contracts are paying between $9-12/GJ to secure gas.
Robertson says the Saudi’s have opened the oil taps and intentionally crashed the price of oil in an effort to gain market share and restore their authority over the oil pricing cartel.
“Discipline in the oil price cartel has been lacking and the Saudi’s are stamping their authority on global markets. It normally takes some time before pricing discipline in the oil market is restored.”
It is not just the markets that have spoken out on the longer term effects of the oil price crash.
The world’s most feted investor, Warren Buffett, has pulled out of his US$3 billion investment in a Quebec LNG plant.