Saudi Arabia declares oil price war
Mark Lacey, Schroders' Head of Commodities, comments on Saudi Arabia's recent decision to slash its oil selling price, which represents the largest cut in prices since at least 2004.
Following the collapse of talks with Russia at the weekend over output quotas, the Kingdom of Saudi Arabia (KSA) has effectively declared a price war in the oil market. It slashed the official selling price (OSP) by $7-$8 per barrel in Europe and the US and $4-$6 per barrel in Asia, the largest cut in prices since at least 2004. In addition, it is being reported locally that the KSA will increase exports by up to 800,000 barrels a day into an already over-supplied market.
The move could cost the country an estimated $120 billion, as the current price is not profitable. In fact, current oil prices are significantly below the fiscal break-evens for all of the OPEC producers. It is difficult to envisage that these prices can be sustained without significant cuts to fiscal programs, which in turn would lead to significant unrest.
If oil prices average $35 per barrel for the rest of 2020, full-year cash flow for the integrated oil companies will reduce by between 50% and 60%. The dividends for all the integrated companies are not covered at $35 a barrel. While we don’t think dividend cuts will happen in the short term, without a crude price recovery dividend cuts are a certainty. No part of the oil industry works at $30 a barrel.
Listed oil companies operating in this environment are more fragile than at any time in the past 20 years. Investors have been selling shares as environmental, social and corporate governance concerns divert capital to the renewable sector. The risks to oil balances for the next few months lie firmly with demand, and large inventory builds will be unavoidable over the next few months. And if we look to the 2021–2025 period, the oil market is undersupplied and we need OPEC to increase production beyond its current spare capacity.
So ironically, the way to look at the oil market is simple. The longer we stay at current oil prices, the more supply will be removed from the industry. This sets the market up for a period of significant tightening and much higher prices, when we finally enter a period of stable demand and restocking. For this stability, we need the coronavirus (COVID-19) to dissipate, industrial activity to restart and industries to destock. In the very short term it is hard to see this happening, but if we look beyond the short term, the upside risk to oil prices is significant.
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