Oil Prices and Human Nature

//Oil Prices and Human Nature

Oil Prices and Human Nature

Over the last several weeks, oil prices have plummeted to lows not seen in decades. Part of this has to do with the economic upheaval that is now part of the Coronavirus fight, but part of it also has to do with unpredictability of human nature. It isn’t Game of Thrones level intrigue, but it is definitely worth watching, if for no other reason than to see how the price of oil will help our economy get back on track when the Coronavirus threat passes.

OPEC, or the Organization of Petroleum Exporting Countries, is a 13 member cartel that controls an estimated 30% of the global oil market. As a trans-national cartel, their objective is to collaborate on production goals and target selling prices received in global oil markets. As the largest producer in OPEC, and the world, Saudi Arabia is the de-facto leader and usually the swing producer that absorbs the largest proportion of any supply adjustments. OPEC has learned not to let prices get too high, which would incent energy users to seek more energy-efficient applications, or too low, which would inhibit their ability to fund other obligations that rely on the sale of oil.

Behind Saudi Arabia, non-OPEC members Russia and the U.S. constitute the three largest oil producing countries in the world. Despite the lack of formal OPEC membership, Russia and several other producers are part of a wider group called OPEC plus that worked under similar objectives. Until now.

Producers quickly recognized that Coronavirus and the associated quarantines would have a fast and powerful effect on the demand for oil. China, the worlds’ biggest oil importer, was shutting down factories, banning travel and halting commerce in an attempt to get ahead of infections. Supply would need to adjust or prices would have to decline.

Fearing just such a decline, Saudi Arabia began aggressively lobbying Russia to join OPEC in production cuts to keep prices from falling too far. Friction between them began early and ended with Russia’s announcement that it would not be cutting production and exiting OPEC plus. Analysts believe Russia is taking a longer-term view. It felt more comfortable operating independently and it believes that cooperating with Saudi Arabia actually gave U.S. producers too much power. Saudi Arabia responded by initiating a campaign to steal market share by cutting their selling prices and raising output at the same time. Markets responded by dropping the price of oil to its lowest level in decades.

With Coronavirus taking over headlines, the benefit of low oil prices have received less attention than they normally would. In the past, lower energy prices induced us to buy bigger cars, to drive more, to fly more, and to invest more. Not this time. Because we are sheltering at home, none of us are taking advantage of these lower prices. Further, with the growth in fracking over the last decade, the U.S. has doubled its domestic oil production and is now an oil exporter, exposing U.S. energy companies to the same market realities as Russia and Saudi Arabia, but without state support.

This is why U.S. energy companies with weaker balance sheets are much more at risk. The landscape has shifted to such a degree that U.S. oil industry regulators have even opened a dialogue with OPEC, something previously considered highly unlikely, even discussing the possibility of supply reductions from the U.S. All this maneuvering and positioning could change the landscape and power structure of oil producers in major ways.

2020-06-17T16:50:43-05:00 March 27th, 2020|Investment Management|0 Comments