The oil business is caught up in a double crisis. There are the damaging economic effects of the pandemic, with demand plummeting, but oil is also being battered by an all-out battle for market share and by surging production, which is driving prices further down. Since the start of the year, oil prices have dropped 60 percent, from $68per barrel to $27 at latest report. That spells deep trouble for debt markets with large borrowings by oil companies.
With the global economy already in crisis, a hammer blow could fall in the next two months if, as seems likely without immediate action, more surplus oil floods the marketplace than at any time in history.
The market-share battle is between Saudi Arabia and Russia. The conflict could always be ended by a phone call among the principals, but given their entrenched positions, stopping the price war and easing the market turmoil may well require collaboration through some broader framework, such as the Group of 20. That would permit a discussion going beyond the present Russia-Saudi impasse, bringing in the United States and a larger group of producers and consumers, including Brazil, China, France, Germany, Mexico and the United Kingdom.
As it happens, the Saudis are chairing the G-20 this year, and are eager to make their stewardship a success. To that end, they have called for the group’s coordination in dealing with the pandemic. Similar work together is essential to heading off the economic damage from an unprecedented oversupply of oil.
The fall in oil prices began in phase one of the coronavirus outbreak, when China’s January shutdown led to a first-quarter 6 million-barrel-per-day drop in global demand. It was the biggest single decline in modern history, far bigger even than in the 2008-2009 financial crisis.
The plunge drove a wedge between Saudi Arabia and Russia, the architects of the 2016 alliance known as “OPEC+” that had stabilized the global market after oil oversupply drove a price collapse in 2014. In early March, Saudi Arabia insisted on deep output cuts to stop prices from falling. Russia, apparently assuming that worse was coming economically as the coronavirus spread around the world, balked at cuts whose benefits would be erased by rapidly declining oil consumption. Settling in for a longer-term crisis, Russia seems to believe that even though its economy is heavily dependent on oil revenue, it is more resilient than those of other producers.
Saudi Arabia swiftly responded, announcing that it was moving to maximum production, adding 2.5 million barrels per day to an already morbidly oversupplied oil market. Other producer countries, including Russia, have answered by adding another 1.5 million barrels per day.
But this supply is flowing into an oil and gas market that is already shrinking fast in phase two of the pandemic crisis, as airplanes are grounded, businesses padlocked, industry not working and people around the world told to stay home.
Everything depends on how the crisis plays out in the coming days, but our organization, IHS Markit, estimates that the drop in consumption could range from 10 million to 15 million barrels per day in the next four to eight weeks — or up to 15 percent of global demand. That would be a staggering, never-seen-before decline. The market could not even begin to cope with a surplus of that magnitude.
In a matter of weeks, oil inventories would swell to a size triple those built up during the 2014-2016 price collapse. Already-low prices would drop further, prompting companies to shut production wells and pull back on investment. Amid such oversupply, the global oil and gas industry infrastructure — from the oil well to the gas-station pump — could face a series of damaging disruptions. At this rate, by the end of April, gigantic bottlenecks will develop in the supply chain because there simply may be no more storage capacity.
The consequences could be devastating for developing countries that have fragile health systems and are reliant on petroleum revenue. But the fallout could seriously damage the U.S. oil and gas industry, regional economies, financial markets and the industrial sector that produces equipment for the industry. Many jobs would be lost and businesses shut down, slashing federal, state and local tax revenue.
The G-20 was founded two decades ago to bring the major-economy countries together to safeguard global economic stability and respond to crises. The G-20 is responding to the pandemic crisis. It needs to respond to the oil crisis as soon as possible.