By Engr. Edgar Mana-ay
Last March 2, crude oil prices plunged nearly 25%, down to $30/bbl (barrel) from $45 to $48 per barrel (159 liters), one of the largest quick decline in decades, sending global markets spiraling, which was already reeling from COVID-19, all over the world.
The oil industry is still the backbone of the world’s economy, contrary to the belief of global warming fanatics that they could do away with fossil fuels even now.
As a background, the U.S. is now, for the last 8 years, the biggest oil producer in the world at 18 million barrels per day (mbd) or an 18% share, followed by Saudi Arabia at 12.5 mbd (12%) and Russia at 11.4 mbd (11%) and Canada at 5.27 mbd (5%).
Of the four, only Saudi Arabia is a member of the Organization of Petroleum Exporting Countries (OPEC) which controls about 18% of the total world oil supply. The OPEC headquartered in Vienna, Austria is headed by the Saudis with Iran, Iraq, Kuwait, Venezuela, Qatar, Indonesia, United Arab Emirates among others as members.
The oil price crash came after Opec and its allies failed to strike a deal with Russia to lower production amid declining world demand. As we all know, in marketing, the most effective way to control prices is to manipulate the supply if we cannot control the demand. This in Economics is the law of supply and demand where in the past, one of our presidents asked: “When was the law passed!”
As in my previous column, I mentioned that the U.S. who was once an oil importer became an oil exporter and the biggest oil producer in the world because shale oil (oil and gas trapped in soil underground is removed by a novel and new method called fracking). But shale oil has its set back. It is the most expensive method to extract oil underground at about $45/bbl break-even cost, more expensive than deep-sea (beyond 16,000 ft.) offshore extraction in the North Sea or the Gulf of Mexico which ranges only at $40/bbl break even. Certainly, if oil prices stay at $30, the US shale drilling will be devastated and that is what Russia is hoping for. That will also return the US into a net oil importing country.
The Opec group headed by Saudi Arabia is the dominant player in the world oil supply because they act as a single voice to control 18% of the supply. Russia is fully independent and will not cooperate either with the US nor the Opec. In fact, Russia has built a $70 billion war chest that Moscow believes will tide the country through an oil revenue famine in case of a prolonged oil price war. The Opec countries, on the other hand, cannot afford the oil price to linger long at $30 because oil revenues are the lifeblood of their economies. Even Saudi Arabia, despite its diversification to industries and agriculture, still relies heavily on its oil revenues which they would want to maintain at the $50 benchmark. Saudi has the lowest oil extraction cost in the dessert at only $28/barrel so that in the $50 benchmark they make a tremendous amount of money at $621 million a day!
The U.S. economy can survive a $30 to $35 oil level but its revenue now will not be oil-based anymore but from other industries, agriculture, manufacturing, of which the US has the largest in the world. China at 4.8 mbd oil production (5% of world supply) is still a voracious oil importer (before COVID-19) because it consumes almost 13 mbd bigger than both the consumption and production of the U.S.
Months before there was an alliance between Saudi Arabia and Russia to reduce production to counter the oil price drop due to the shale oil production of the U.S. Now that cooperation between the two of the world’s three largest oil producers (the 3rd is the U.S.) appears to be at an end. Saudi Arabia as the dominant member of the Opec proposed production cuts to offset the collapse in demand (about 30%) due to the spreading of the coronavirus outbreak. Russia which is not an Opec member refused to go along and the impasse has turned to open hostilities. Saudi had given Russia Energy Manager Novak that they should trim production by 1.5 mbd or about 1.5% of the world supply and Saudi would make the bulk of the cut at 1.0 mbd but still Russia refused. Previously there was also an agreement to cut 2.1 mbd which will expire March and again Russia refused to abide.
The Saudis struck back by notifying its buyers of big discounts on their April sales. Because of this, the market was spooked by a potential deluge of crude, hence the oil crash by 30%. Today the price of oil and the stock market had recovered but the oil market is far from stable. Pump prices for gasoline and diesel hovers at P50 plus and P40 plus per liter respectively which we expect to go down a little in the next few weeks.
This writer believes that a stable oil price of $40 to $45 per barrel is beneficial to everybody, the poor importing countries and the rich producing countries. Still, a price war carries huge risks such as depriving oil-producing countries to finance its infrastructure spending that had caused the hiring of more than 100,000 Filipinos skilled workers in the Middle East. Just imagine the number of dollars these kababayans of ours are sending home. At a time when the world is threatened by a pandemic coronavirus, health care costs might also be jeopardized. Playing Russian Roulette in the oil market may have grave consequences.
