Oil drops sharply as Saudi Arabia starts price war

coronavirus, oil prices, price war, Saudi Arabia, US shalecatmoz / Pixabay

Oil prices plunged by over 25% on Monday after Saudi Arabia launched a price war, triggering a global market sell-off. The Kingdom’s decision to lower oil prices and start a price war can partially be attributed to the oversupply of oil created due to the coronavirus.

Global markets in turmoil

Saudi Arabia, a top oil exporter, lowered its oil prices last week after it failed to convince Russia on the production cuts. On Monday, the benchmark Brent oil futures dropped to $31.02, while West Texas Intermediate crude was down over 22%, its biggest loss since the launch of Desert Storm in 1991.

Along with the oil price, stock markets worldwide, which were already in panic mode, also witnessed a sharp drop. On Monday, Asian markets witnessed heavy selling and the same was the case in Europe with FTSE 100 losing over 8%, Germany’s DAX down over 7% and Italy’s main index down almost 7%.

Stock index futures also dropped due to the plunge in oil prices and growing coronavirus concerns. Gold, on the other hand, which is seen as a safe haven, surged above $1,700 per troy ounce, the highest in seven years.

Why did Saudi start a price war with demand already dropping from coronavirus ?

Last week, Saudi Arabia had met with Russia and other non-OPEC members. The agenda of the meeting was to discuss response action to the dropping oil demand due to the coronavirus outbreak.

However, the parties failed to reach a consensus over slashing production by as much as 1.5 million barrels a day. This led to a disruption in Russia’s three-year alliance with Saudi Arabia. However, many believe the disruption to be temporary.

Thereafter, Saudi Arabia announced a drop in its April selling price by $6 to $8 to gain market share and put pressure on Russia, analysts say.

Initially, the Brent dropped to below $50 on Friday. But, following Saudi Arabia’s decision, the downward trend carried over to Monday. Market analysts were shocked over the disagreement between OPEC and Russia.

“The collapse of the Opec/non-Opec alliance is a major shock to the oil market, and it comes with the added challenge that we don’t have the full picture of what lies ahead,” Vandana Hari, an energy analyst of research firm Vanda Insights told the BBC.

Coronavirus & oil price war lead to growing recession fears

Currently, global oil demand is much lower than the supply. Oil prices are now nearing a 16-year low. Oil demand has come down as people around the world are canceling their travel plans due to the outbreak. Economists are worried that the outbreak would push economies into a recession, resulting in even lower demand for oil.

This recent drop in oil prices due to the price war and coronavirus is another blow to the financial markets worldwide, which have been under pressure for over a month now. Treasury yields have dropped to record lows as investors are switching to anything that looks safe even if it provides a lower return. On Tuesday, the 10-year Treasury yield fell below 1% and on Friday, it dropped even lower to 0.70%.

On Monday, rating agency Moody’s said that the risk of a global recession is growing because coronavirus is resulting in a supply and demand shock worldwide. The OECD said last week that the outbreak might lower the global growth by 0.5% to 1.5%. Moreover, the World Bank and the International Monetary Fund (IMF) say they are keeping aside billions of pounds to fund health systems in developing world countries.

Are US shale oil producers the real target?

Saudi Arabia also reportedly has plans to boost oil production by over 10 million barrels per day. Saudi Arabia’s strategy to gain market share by increasing oil production has been termed as a “shock-and-awe” strategy by AxiCorp chief market strategist Stephen Innes.

The oil industry has seen similar situations before as well. OPEC held off production cuts in 2014 to hold on to market share amid the rising U.S. oil industry. At the time, oil prices dropped to below $40 from over $100 a barrel.

Many believe that Russia not agreeing to a production cut could increase challenges for the U.S. shale oil producers, many of whom need higher oil prices to survive. In a note to clients Sunday, analysts at energy consulting firm FGE said that Russia has long been hinting that its real targets are the U.S. shale oil producers.

Russia is “fed up with cutting output and just leaving them with space,” FGE analysts said, according to CNN. “Such an attack may be doomed to failure unless prices remain low for a long time.”

At the time of the 2014-2016 oil crash, several oil and gas companies filed for bankruptcy, while many other resorted to layoffs. But, the U.S. shale industry got stronger.

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About the Author

Aman Jain
Aman is MBA (Finance) with an experience on both Marketing and Finance side. He has worked as a Risk Analyst for AIR Worldwide, and is currently leading VeRa FinServ, a Financial Research firm. Favorite pastimes include watching science fiction movies, reviewing tech gadgets, playing PC games and cricket. - Email him at amanjain@valuewalk.com

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