US, WASHINGTON (ORDO NEWS) — In a sea of bad news about coronavirus, a drop in oil prices may seem like the only positive note. Lower fuel prices will help consumers in the face of a pandemic and its economic impact. Be that as it may, the new oil crisis could entail the same profound upheavals for the world economy and geopolitical equilibrium as the 1973 crisis (even if it was a question of raising prices then).
As in the past, the new crisis has largely become the work of the producing countries themselves. Starting a price war in the midst of a pandemic, Saudi Arabia and Russia decided to increase the impact of exogenous shock (coronavirus and its effect on oil consumption in China and other countries) with an endogenous response: expansion of production.
This decision, which took the market by surprise, brought down WTI quotes of American oil below the mark of $ 20 per barrel (the worst figure for 18 years). At first glance, it is a gross mistake that analysts have called “collective suicide.” Since the world’s largest exporters are heavily dependent on oil revenues, Riyadh and Moscow themselves were the first victims of overproduction. Be that as it may, from the point of view of game theory, such an intuitive solution is a masterful move, and the two oil giants are already beginning to reap its benefits economically and geopolitically.
This is precisely what the new oil market model based on the middle field theory indicates, which was created by two authors of this theory, Pierre-Louis Lyon, Jean-Michel Lasree, as well as Antoine Rostand, president of the Kayrros analytic company and Jose Scheinkman, an American economist.
Their model represents how large exporters of cheap oil-producing oil (the “dominant monopoly”) are constantly looking for a balance point between two conflicting goals: high prices and market capture. When prices rise, giants earn more, but lose market share in favor of smaller oil producers with higher costs (rising quotes push them to more production and investment in production opportunities). Be that as it may, their synchronized reaction leads to lower prices and increases their vulnerability to falling quotes. In such circumstances, giants can win market share by falling prices. The stronger the drop, the more painfully it hits small producers and the more profitable it is large.
To organize a recession, giants usually need a push, an exogenous shock. In the late 1990s, it became the Asian crisis and its negative impact on demand. In 2014, it was a question of a shale revolution. The model drawn up by specialists has for some time assumed a new recession. The coronavirus became the detonator.
Although the phenomenon itself is well known to everyone, now it is extremely fast. The fact is that the destructive effect of coronavirus on demand provides large manufacturers with the opportunity to test the limits of global storages. Unlike what happened in 2014, price reductions alone cannot stimulate demand due to restrictive measures. As a result, excess production is immediately sent to the vaults of market participants who have the opportunity and are waiting for the economic recovery with an inevitable increase in prices. However, storage is not unlimited, which continues to pull prices down.
Satellite images today allow us to evaluate these opportunities (in 2014 it was not available) and track global reserves in real time. According to Kayrros, from late February to late March, world reserves grew by more than 100 million barrels – an unprecedented figure.
This growth is only gaining strength and should significantly exceed 4 million barrels per day, with the expansion of social isolation in the United States, the main global consumer. At the current pace, the ceiling will be reached in a few months or even weeks. The closer to it, the lower the price. In this case, everything will come to negative prices: the producers themselves will pay the buyers to take their oil. The smallest of them will be forced to plug wells, possibly forever. Victory for the largest.
It is already starting. Bloomberg has already reported negative prices in Wyoming. On Sunday, Ryan Sitton of the Texas Railroad Commission (an agency that regulated production before OPEC took over half a century ago) tweeted that US shipping companies were asking customers to cut production because of a lack of storage facilities.
Apparently, the sudden decline in consumption reduced the available storage volumes, creating “dams” and hindering system optimization. In turn, speculators can reserve empty storages in order to increase pressure on the market and fill them at the lowest possible prices with an eye to their further growth.
Shale Oil Impact
A real triumph for Moscow and Riyadh would be the taming of shale oil, whose development has turned the United States from a major importer to a major exporter. Now this goal, apparently, has almost been achieved. A year ago, Congress again began consideration of the so-called NOPEC law, which was supposed to outlaw OPEC, which caused concern in Riyadh.
Last week, 13 senators, including representatives of North Dakota and other oil-producing states, appealed with the support of part of the industry to Saudi Arabia with a request to restore control.
The law put a cross. Reportedly, Seatton could begin negotiations on a production control agreement between Texas and OPEC. The federal government is probably also conducting such negotiations with Riyadh.
These efforts are supported by the main “independent” producers of shale oil, including industry-respected Scott Sheffield, CEO of Pioneer Resources. According to him, in the absence of measures to restore prices, only a dozen of the 75 independent producers listed on the stock exchange will reach the end of 2021.
Double edged sword
In this way, the US learns that oil domination is a two-edged sword. Although the rise of American production allowed Washington to use oil weapons more freely in international relations, the collapse indicates that all this connects its interests with those of Moscow and Riyadh, and not only frees it from its former dependence on imports.
The model perfectly demonstrates how a “dominant monopoly” can put pressure on its members to force them to share the burden of reducing production, which entails market fluctuations. Having launched a price war, Riyadh and Moscow de facto force Washington to accept the club card.
Thus, after the fall, the market will have to deal with a new geopolitical alignment. The shale industry has accelerated the restructuring process that began before the collapse, and the old confrontation between producers and consumers, OPEC and IEA, can be replaced (officially or unofficially) by a new management system in which Moscow, Riyadh and Washington will share market control levers.
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The article is written and prepared by our foreign editors from different countries around the world – material edited and published by Ordo News staff in our US newsroom press.