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What Saudi Arabia and Russia do next

The Opec+ heavyweights underestimated Covid-19’s impact on demand. It may be too late for them to staunch the bleeding

“Russia and Saudi Arabia will have to talk to each other—this [situation] is much more dramatic than they expected two weeks ago.” So says Per Magnus Nysveen, head of analysis at Oslo-based consultancy Rystad Energy. But it remains doubtful whether the erstwhile Opec+ partners, having released the genie from the bottle, can put it back in.

Both the NOCs and the IOCs are still in the shock phase. They do not know what to do,” says Nysveen. “They are almost behaving just as they have done before. And they have had some scope to do so before all storage is filled up.

“They are only now thinking: what should we do? They are taking some practical measures, e.g. taking as many platforms as they can off for maintenance, if only for HSE reasons to minimise the potential virus spread among offshore workers. But there are no historical examples to help model the approach going forward, this has never happened before.”

Demand trumps supply

The problem that Saudi Arabia and Russia face is that the extent of the demand rout has left a huge supply-demand gap—from 15mn bl/d to well over 20mn bl/d depending on analysts’ methodologies—that cannot be plugged simply by a new Opec+ accord.

Between them, the two producing powerhouses could “at best, take 4mn bl/d out of the market”, says Nysveen, nowhere near enough to match the lost demand. He stresses that any new accord “would be psychologically very important in delaying the time it takes to reach the ceilings of storage tanks around the world”.

“But you will be surprised to see how little they actually can do. All types of production have to give in, not only Opec+ production,” says Nysveen.

“Both NOCs and IOCs are still in the shock phase. They do not know what to do” – Nysveen, Rystad

The question is whether either is in a mood to compromise. Russian officials seem to be more conciliatory. On the other hand, the 17pc depreciation in the Russian rouble against the US dollar improves the robustness of Russian producers relative to Saudi Arabia in a low oil price environment, points out Alexandre Andlauer, an analyst at cargo tracking firm Kpler.

And there is no sign yet that Saudi Arabia will step back from its planned April production ramp-up. Kpler estimates the Saudis’ declared target of 12.3mn bl/d of supply to customers in April will translate into 10mn bl/d of exports, well above the 8.2mn bl/d monthly peak the cargo tracker has recorded in recent years.

It calculates Saudi production could reach 12mn bl/d, but only in 4-6 months, so hitting 12.3mn bl/d will require Saudi Aramco to dip into its storage—quite hard initially, reducing as production increases but not being eliminated entirely. Conveniently, Saudi storage has been building of late, according to Kpler tracking, but the firm still expects the April export increase from the kingdom to undershoot its target and come in more in a 1-1.5mn bl/d extra range.

US impact

Why might Saudi not alter its course? It may feel the tactics it tried and failed with in 2014 to drive US production out of the market and permanently dent the US’ market share may work better this time round.

Current production across all US shale basins is 8mn bl/d, according to Andlauer. But the legacy production change—the drop in output if there is no more fracking and no completions in the next 12 months—is 3.8mn bl/d. While there will obviously still be some completions going forward, “keep in mind that the [US shale] production decline is extremely high right now”, he cautions.

“We do not expect US players to be as strong as they were in 2015; we are not in the same situation,” Andlauer continues. “If WTI stays below $30/bl, we will for sure see some impact in the second half of the year, especially because that means local prices are some $5-7/bl lower still.

15-20mn+ bl/d – oil supply/demand gap

“But the key reason why today is different to 2015 is that there is no more private equity betting in the sector. It is impossible to do an IPO in the oil and gas sector, so it makes no sense to inject any capital into a company because there is no exit strategy. It was totally different in 2015 and 2016.”

Other factors also weaken US shale producers compared with five years ago, in Andlauer’s view. One is that debt gearing rations are much higher than in 2015. Another is that the technical learning curve in shale plays is now much different—the potential to reduce costs is much more limited.

“Basically, US shale oil producers cannot survive as they did in 2015,” he concludes.

Rystad is also bearish on the prospects for US shale, but not immediately. “Even at $20/bl, we do not see significant drops [in US output] before the third quarter,” says Nysveen. But if WTI stays in a $20-30/bl range, Rystad forecasts a 1-2mn bl/d drop for the second half of the year.

But Nysveen also cautions that as much as 75pc of US production may be hedged, which would in theory allow deliveries to continue at prices much higher than spot levels. But this is dependent on there being demand-side actors or available storage to physically take delivery on the volumes.

“You might see in certain places like the US and Canada, where economics becomes less important than logistics. Even if you have very low marginal costs of lifting, you will still see them stopping delivering because there is no storage.”   

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