OPEC and Russia ‘jump off the cliff together’ as coronavirus hits oil demand

The collapse of an international accord to curtail oil exports in the face of falling demand due to the coronavirus will lead to a prolonged oil price crash, experts warned on Monday.

Russia walked away from a deal with OPEC and nine other oil exporters to curtail supplies at a meeting in Vienna on Friday, with Energy Minister Alexander Novak announcing the start of a battle for market share that sent world prices spiraling 30 percent lower on Monday.

Roger Diwan, Vice President of IHS Markit, said Russia and OPEC had been drifting apart for a few months leading up to the Vienna debacle: “There was no agreement going into Vienna and no ‘Plan B’. In the event, they decided to jump off the cliff together,” he told Al Arabiya English.

The surprise decision to end a three-year partnership to stabilize world oil markets defied expectations. Brent futures suffered the second-largest decline on record in the opening seconds of trading in Asia, behind only the plunge during the Gulf War in 1991. As the global oil benchmark plummeted to as low as $31.02 a barrel, Goldman Sachs Group Inc. warned prices could drop to near $20.

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“We are predicting the biggest demand shock in the history of the oil markets over the next six months, combined with a supply shock. This summer we see a crisis that will affect the market for the next two years,” said Diwan.

Saudi Arabia's Minister of Energy Prince Abdulaziz bin Salman Al-Saud and Russian Energy Minister Alexander Novak at a meeting in Vienna. (Reuters)

Saudi Arabia, OPEC’s biggest producer, immediately indicated its intention to protect its market share with steep price discounts for its crude oil shipments. On Tuesday, the Kingdom is expected to announce a sharp hike in supplies for its customers in April.

Instead of reducing output by another 1.5 million barrels per day (bpd), as OPEC had proposed before Russia walked away from the deal, the 13-member oil exporters’ club is now expected to hike output by 1.5 to 2 million bpd next month, according to Gary Ross, CEO of Black Gold Investors.

This drastic swing in supply comes at a time when demand is cratering due to the economic slowdown caused by the coronavirus epidemic. The International Energy Agency (IEA) predicted that oil demand would contract this year for the first time since 2009. It cut its annual forecast by almost 1 million bpd, signaling a contraction of 90,000 bpd.

IHS Markit’s Diwan said the demand outlook was bleak: “We are expecting a decline of 4 million barrels per day in the first quarter and in the second quarter we don’t know.”

Read more: Coronavirus fears shock markets, drive oil prices down

The Organization of the Petroleum Exporting Countries, led by Saudi Arabia, had taken the lion’s share of the burden to keep oil prices stable above $50 a barrel – seen as a minimum break-even level for many government budgets – under the three-year accord. But as OPEC’s market share has declined over the past decade, the arrangement was viable only if Russia and nine other major exporters, known as OPEC+, joined in.

Saudi Arabia and Russia last battled for market share in 2014 when they tried to put a squeeze on production from the United States, which shuns market management deals and has grown to become the world's biggest producer of crude.

Ross said Russia had made a mistake that would cost it dearly. The Russian ruble slumped to its weakest level since early 2016 on Monday, falling 7.7 percent to 74.40 per dollar.

“Russia’s position was totally unreasonable. They showed they were not real partners to Saudi Arabia. They were just free riders,” said Ross.

Oil has always been a cyclical business – prone to dangerous booms and busts – ever since it was controlled by the original American oil cartels of the first half of the 20th century: first the Texas Railroad Commission and then the oil majors known as the Seven Sisters.

Since OPEC took over the responsibility to manage global supplies in 1960, it has had a mixed record, with periodic sharp swings in the price since the 1970s. For the past three years, Saudi Arabia has informally targeted about $70 per barrel, while Russia was content with $50, said Diwan.

“Ultimately Russia just didn’t feel a further cut made sense with the demand destruction that is going on… The oil market needs management, but Russia decided that it doesn’t want to play that role any more,” he said.

Ross said a free-for-all was the only logical outcome after Russia opted against deeper cuts to address the unprecedented demand shock brought by the coronavirus epidemic.

With Saudi Arabia’s announcement of deep discounts for its crude oil supplies to Europe, the stage is set for a bruising battle for market share as demand slows.

“At such a time of uncertainty and potential vulnerability to the world economy... playing Russian roulette with the oil markets may well have grave consequences,” said the executive director of the International Energy Agency, Fatih Birol.