Marius Paun | London, UK | Senior dealer | Wednesday, 11th March 2020
The world markets woke up on Monday morning to see oil prices plunging over 20%. It hit multi-year lows, the worst day since 1991 and no, the panic on this occasion was not spurred by the dramatic mutated strain of coronavirus. Rather, it was the result of an oil price war between Saudi Arabia and Russia.
Let’s step back, look at the facts in the current context for the oil sector and try to see some possible effects for a number of players.
On Thursday last week, OPEC+ (OPEC + Russia) met in Vienna and recommended an additional output cut of 1.5 million barrels per day, starting in April, until the end of 2020. The talks broke down as Russia rejected the proposal. In turn that triggered the sell-off in oil prices, already under downside pressure by the widespread fear of a global recession due to coronavirus. Then, over the weekend, things got really messy.
Saudi Arabia announced massive discounts to its clients and said it will increase production. It currently pumps just under 10 million barrels per day and has the capacity to ramp it up to 12.5 million barrels (there are already rumours the kingdom will pump over 12 million barrels pretty soon). To counter this, Russia promised to follow suit. The OPEC+ meeting ended with no decision on the existing output cuts, set to expire at the end of March. Russian Energy Minister Alexander Novak said his country will stop ‘minding quotas or reductions which were in place’.
The million-dollar question is why now? There seems to be an unusual timing linking the OPEC decision, or perhaps more accurately ‘no decision’, to coincide with the coronavirus outbreak. Crude prices have already moved sharply down this year due to softer demand so a potential glut could only make things worse.
On top of that, the elephant in the room is the US shale oil production. It’s probably worth remembering that shale production has helped the US achieve energy independence. And that probably changed the geopolitical status quo, which is difficult to fully understand. The US now pumps over 13 million barrels per day and almost 9 million barrels come from shale oil. It’s ironic that Saudi Arabia has been supporting crude prices for years through production quotas and ‘temporary output cuts’ which kept alive the higher-cost US shale producers.
Is Saudi Arabia now trying to put US shale producers out of business, as it tried in late 2014, thinking that this time coronavirus has already contributed to a significant collapse in oil demand, and they need to only deliver the final blow? Are they re-playing the game of bleed now, but destroy the competitors and gain market share in the long run? Crushing oil prices would probably hurt both countries hard. Saudi Arabia would lose government revenue and apparently its fiscal budget balances well above the current oil prices. At the same time, the US would see its new-born shale industry facing bankruptcy. On the positive side, low oil prices will be well received by consumers, airlines, shipping and mining companies, but oil companies, in general, will pay a heavy price.
For the Saudis, there could be a little extra as well; slowing down that incredible rush to electric cars by making petrol a lot cheaper. The electrification of everything, and the speed of its adoption around the world, really could be another existential threat to the Kingdom and they may take the view that this acceleration is becoming a lot more serious a threat. At the end of the day, the Kingdom knows that it has the lowest oil production cost so they could easily be the last man standing.
What about other players? Iran, a well-known enemy of Saudi Arabia, is already reporting significant casualties caused by the virus outbreak. Their revenues will be further hit by lower oil prices, so the government could see increasing social unrest. Will they react? They do control the Strait of Hormuz through which a massive quantity of global oil supply flows. Consequently, another drone strike attack on Saudi oil production should not be disregarded.
Venezuela also comes to mind as the South American country has now the world’s largest proven oil reserves. That prize alone coupled with the fact that it sits in the relative US’s backyard could make us wonder if another ‘Operation Freedom’ is not in the cards. The state oil company in Venezuela produces a third of the amount of oil it did in the pre-socialism era and its workforce has apparently more than tripled. How long can they last now?
Let’s take a look at the long-term chart:
The momentum now is clearly with the bears as indicated by the moving averages. The short-term MA (red line) has crossed below the longer-term one (blue line), both are pointing downwards and the price is well below both indicators. We’re now looking at lows of mid-2015 for support, below $28.00 level.
On the upside, a sustained move above $38.8 which is 23.6% Fibonacci retracement will indicate the bull is having some success in making a comeback. That target needs to be confirmed if the rally back has any life in it. Buyers could be looking at $42.00 – $42.50 range as the next resistance level.
On the downside, the immediate target is $33.5 just below the current price which provided relatively good support during mid-2015. The current downward move seems to have enough momentum to retest the support at $27.68 which held well during Monday’s session. Notably, we can see three consecutive downwards candles (‘three black crows’ pattern) which is a rather bearish signal.