Oil prices- what caused the collapse?


New market and price war has begun

Oil prices fell the most in one day since the 1991 first Gulf War. The price of U.S. crude fell as much as 34% to $27.34 a barrel, a stunning drop for one day and the lowest price since early 2016. The international Brent benchmark had fallen from $69 at the start of the year to around $50 last week.

But the failure of OPEC and non-OPEC members to reduce the supply caused sharp fall on Monday.   The oil price collapse will have significant implications for oil companies- oil producing countries and especially for American energy market. This sharp decline is the result of four factors.
One- The price war between two biggest oil producing countries Saudi Arabia and Russia is the main reason of this sudden oil price crash. The clash of oil titans has send shock waves across the energy markets. There is surplus supply in the market. Saudi Arabia was trying to convince the Russia to cut the oil production to stablise the prices but Russia refused.
The OPEC and non-OPEC members in a meeting last week failed to agree on a production cut of 1.5 million barrels a day, or about 1.5% of global production. The idea was to keep prices from sagging even more as demand is expected to fall this year.
In retaliation-Saudi Arabia increased supply and triggered the collapse of oil prices. The decline followed Russia's refusal last week to join the OPEC oil cartel in proposed production cuts aimed at supporting prices.

Thwarted in its search for cuts, Saudi Arabia, the leading OPEC member, sharply changed course over the weekend by cutting prices and signaling it will ramp up production.
 Saudi Arabia now wants to cause maximum pain to Russia. Russia is already feeling the pressure on its currency Ruble.
 Two- The fear of Coronavirus spread has already slowed down the world economies. The World economy was already losing steam before the outbreak of coronavirus in China. The slowdown in world economy reduces the demand of oil. The consumption of oil dropped due to the economic slowdown and restriction imposed on travel after the coronavirus outbreak.
The coronavirus outbreak is squeezing economies around the globe to the point where world oil demand is forecast to shrink in 2020 for the first time since 2009. The growth in World economy was already falling but Coronavirus further cause disruptions. Many global business events have been cancelled because of coronavirus.
Third- There is renewed struggle between big oil producers to keep the market share. The increased production from U.S has threatened both Russia and Saudi Arabia. Every major player in the energy market wants to maintain its share in the global market.
Russia may have seen no point in cutting production only to lose market share as U.S. shale producers in Texas and New Mexico take up the slack. Analysts say Saudi Arabia may be underestimating Russia's ability to weather low prices. Both countries are heavily dependent on oil revenues for their state budgets. But Russia says it can balance its budget at around $42 a barrel for its own benchmark crude. Saudi Arabia, whose economy is less diverse, needs more than $80 per barrel to keep economy moving.

Fourth- The U.S was using the shale oil to increase its market share in global markets and also to keep the oil prices low. The American strategy was to put maximum pressure on Russia to reduce its market share. Russia increased the oil production to keep its share.  
Russia has adopted a strategy to cause maximum pain to U.S Shale oil producers. The Russians are doing this out of long-term strategic considerations. Their view is that by doing this they can damage the financial health of U.S. shale-oil producers and that by doing this they can take a lot of U.S. capacity offline and thereby remove U.S. producers as a source of competition. The other thing that is on their mind in all this is that if they cut then that will also primarily benefit U.S shale producers.  
The current low prices could constrain activity in the American shale oil industry. A downturn in oil prices in 2014-2016 hurt companies in places like the Permian Basin in west Texas and eastern New Mexico. According to the Federal Reserve Bank of Dallas, $50 per barrel is the price at which it becomes profitable to drill a new well in the U.S. Large producers such as Exxon have already scaled back with prices at $50 a barrel.

In Texas, the number of active rigs fell from 553 in in October 2018 to 398 in January 2020. Around the same time, the oil industry in Texas shed about 14,000 jobs.
The Big 03 of oil industry is playing dangerous game with each other. It can cause serious damage to world economy and to oil industry.  

Khalid Bhatti


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