Coronavirus Hits the Global Oil Market
by Zeynep Beyhan
On 06 March 2020, at OPEC’s headquarters in Vienna, the Organisation of Petroleum Exporting Countries (OPEC), and its partners (re: the OPEC+ grouping), gathered to discuss whether to cut oil production since the coronavirus slowed the global economy. Although OPEC was willing to implement steep production cuts to eliminate the adverse effects of coronavirus on their economies, Russia balked. The OPEC+ inability to agree to a deal sent oil prices plummeting by some 30%—the sharpest decline since the 1990/1991 Gulf War. Coupled with Saudi Arabia’s reiteration of oil flow increases next month, global markets now face an ‘oil price war’ between key producers. Understanding the impact is a must.
Each news item about coronavirus significantly affects oil prices. As the epidemic spreads — notably, but not exclusively, in China and Italy — factory after factory, manufacturer after manufacturer has been forced to shutter or, at the least, reduce their workforces and/or shifts. As a result, oil-demand tanked. As long as concerns over the coronavirus continue to plague national and international economic life, oil prices may not improve. A possible oil price war scenario can be interpreted in two ways in terms of winners and losers.
In the case of an price war, oil-exporting countries— notably, Russia and Saudi Arabia escalating a probability of oil price war— will be affected negatively by low oil prices— even though not in the short term. In the global market, prices should not fall below a certain level to balance the budgets of countries’ economies, which are heavily dependent on the export of oil-natural gas and this level changes according to countries’ economic and geographical conditions. According to International Monetary Fund (IMF) projections for 2020, Saudi Arabia needs oil at $77/$78 per barrel to balance its budget, while this level fluctuates around $79 a barrel for Libya, $124,4 for Iraq but only $40 for Russia. In this context, Russia looks able to withstand a low price strategy for a while because it is armed with some $570 billion in reserves prices. Yet Saudi Arabia balances its budget at a lower-level compared to Russia and can also sustain a low price for some time by taking advantage of both its reserves worth $500 billion and its ratio of total debt to gross domestic product (GDP) approximately 25 per cent. Soon after, those low prices would lead to a detrimental effect on their economies. If oil prices fluctuate at around $30 per barrel into the summer months, some — notably Russia—may not be willing to further run the risk of maintaining a cumbersome budget deficit and to reduce financial reserves.
So, who will gain from this process? The oil-importing countries, which are not obliged to halt their mass-production because of coronavirus inevitably will take advantage of this process in the case of an oil price war, while the oil market is grappling with fast-spreading coronavirus. These countries will both continue their production and benefit from low oil prices. For instance, lower oil prices will wipe $12 billion from Turkey’s energy importation bill by the end of this year compared to previous year (re: more than $40 billon) if they average $45 a barrel in 2020. Furthermore, the decline in oil prices would lead to reduced current account balances. For each $10 decreases in oil prices diminishes current account deficit by, roughly, $4 billion, reported by Professor Erhan Aslanoğlu (Vice President of Piri Reis University in İstanbul). Moreover, Pakistan can benefit from the drop in oil prices. Due to the deadly virus, the decision to temporarily halt production is not yet on Pakistan’s agenda. It is estimated that low oil prices would considerably reduce Pakistan’s external account since 26% of Pakistan’s imports are oil price-driven. According to Topline Securities— one of the fastest-growing brokerage house in Pakistan — every $20 a barrel decline in oil prices would shrink Pakistan’s oil import bill by $3.8 to $4.2 billion—the current account deficit could be reduced by 50%.
Addtionally, the OPEC+ failure affects the entire oil market and its many up- and down-streamed industries. Gold for instance — commonly accepted as ‘a safe haven’ during periods of political and financial uncertainty — will increase in tandem to the rapid drop in oil prices; it jumped from $51,120 (USD) last week to $53,668 (USD) as of Tuesday, 10 March 2020 re: in the aftermath of the OPEC+ meeting in Vienna.
Consequently, global markets are in turmoil after the OPEC meeting following the outbreak of coronavirus. As long as the pandemic lasts, there will be profound impacts on the global oil market. The oil-exporting countries rule the game and if they insist on lower oil prices, it will cause serious global problems. Even if oil-importing countries take advantage of this process for a while, they will face severe difficulties, sooner or later. The fear that oil prices will remain at a low level escalate concerns over potential oil company bankruptcy. Panic would possibly lead to ‘hard sell’ in the oil market and a domino effect would be triggered. So, the coronavirus effects could turn into a financial crisis. Considering these potential risks, OPEC+ should urgently get back to negotiating table to relieve oil market pressure, instead of raising ‘oil price war’ tensions.
24 March 2020
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