Saudi Arabia attempting a scorched earth strategy to get a production cut.
Executive Summary: Global markets are attempting to price in the double-whammy of the Saudi price cut and production increases, all while trying to gauge the COVID-19 impact to the global economy. We anticipate continued price swings for crude oil, which may get pushed down into the low $20s.
Global crude oil prices plunged more than 30% in trading on Asian markets on March 9 (Sunday night for US). In the US, crude oil prices† declined nearly $12 on the open to $30 per barrel on Sunday night. That is more than a 50% drop year to date, having ended 2019 at $61.06 per barrel.
The Organization of Petroleum Exporting Countries (OPEC) held meetings in Vienna this past Thursday. On Friday, OPEC held meetings with the wider OPEC+ group, which is OPEC member countries plus the 10 non-OPEC nations—most notably, Russia, Mexico and Kazakhstan (collectively known as OPEC+).
After the breakdown of extended talks, Saudi Arabia—through its state-controlled energy company Saudi Aramco—immediately dropped the price offered for March deliveries by $6 to $8 depending on the country. Furthermore, Saudi sources let it be known that Saudi Aramco plans to increase output in April to above 10 million barrels a day (mbd) from about 9.74 mbd in February and could allow it to climb as high as 12 mbd. Saudi Arabia’s moves appear to be intended to gain market share and punish their adversaries within OPEC+.
Context: Saudi Arabia’s Leadership
Saudi Arabia has long been the leader of OPEC, accounting for approximately a third of OPEC production, and generally dictating production quotas to other members. Alternatively, Saudi Arabia has typically felt the pain of taking the brunt of production cuts “for the good of the group” when necessary, which translates into lost market share and revenue for the kingdom.
The Saudi moves appear to be intended to force OPEC+ to agree to a production cut. Russia is among the key holdouts for production cuts and grudgingly agreed to relatively modest cuts over the past few years. The flood of excess production will push revenue downward for all producers, although most OPEC+ producers are controlled by their respective governments. That said, Saudi Aramco is now a publicly-traded company, having floated roughly 1.5% of the company’s shares to outside investors as part of a $29 billion initial public offering back in December. This could complicate the calculation for the kingdom if global investors sour on Saudi Aramco.
Nonetheless, previously similar brute force attempts by the Saudis to get OPEC production cuts have backfired. The most recent example was in late 2014, when Kuwait, the United Arab Emirates and Venezuela balked at reduced production quotas. The kingdom boosted production in early 2015, which pushed prices down roughly 45% over the next year to $26 per barrel. Finally, OPEC agreed to new production cuts, but the kingdom took the bulk of the reduction.
Sooner or later the pain of lost profits typically prevails. However, it might take more pain for OPEC+ to arrive at that point. Conversely, ignoring the egos and pride involved, this issue could be resolved relatively quickly.
US Economic Impact
The US economic impact of the sharp decline in crude oil prices is not as large as it has been in the past, whereby a drop in price was a clear benefit to US consumers and the economy, particularly as the US has increasingly produced and exported crude oil.
The amount of economic activity generated from one unit of crude oil has steadily increased over the past quarter century, improving 61% for the US since 1990 thanks to new technologies, which have driven fuel efficiency and alternative energy sources, including natural gas for transportation. While lower gasoline prices will certainly help low-income Americans keep a little more of their hard-earned money, the savings for most Americans and US-based companies is not as large. Ultimately, this means that the US economy gets less lift by lower crude oil prices than it had during prior business cycles.
Additionally, with the size of US crude oil production nearing 13 mbd, the decline in prices negatively impacts US energy investment, including the build-out of increased exploration and production as well as pipelines to carry crude oil and natural gas to end markets. In the past 20 years, US employment in oil & gas extraction and support activities has grown 80% to just over 400,000 workers. Thus, the sharp decline in crude oil prices puts some of these jobs and investment at risk.
Global markets are attempting to price in the double-whammy of the Saudi price cut and production increases, all while trying to gauge the COVID-19 impact to the global economy. In our opinion, this is too many moving parts for global markets to digest. We anticipate continued price swings for crude oil. Our initial take is that crude oil prices will continue to slide lower before this issue is resolved, perhaps down to the low $20s.
This material was provided by SunTrust Private Wealth Management for use by BB&T Wealth
Advisory managed account programs entail risks, including possible loss of principal and may not be suitable for all investors. Please speak to your advisor to request a firm brochure which includes program details, including risks, fees and expenses.
SunTrust Private Wealth Management is a marketing name used by Truist Financial Corporation and the following affiliates: Banking products and services, including loans and deposit accounts, are provided by SunTrust Bank and Branch Banking and Trust Company, both now Truist Bank, Member FDIC. Trust and investment management services are provided by SunTrust Bank and Branch Banking and Trust Company, both now Truist Bank and SunTrust Delaware Trust Company. Securities, brokerage accounts and /or insurance (including annuities) are offered by SunTrust Investment Services, Inc. (STIS), BB&T Securities, LLC, P.J. Robb Variable Corp. and Precept Advisory Group, LLC, which are SEC registered broker-dealers, members FINRA, SIPC, and a licensed insurance agency where applicable. Investment advisory services are offered by SunTrust Advisory Services, Inc. (STAS), GFO Advisory Services, LLC, BB&T Securities, LLC, Sterling Capital Management, LLC, and BB&T Institutional Investment Advisors, Inc., each SEC registered investment advisers. BB&T Sterling Advisors, BB&T Investments and BB&T Scott & Stringfellow are divisions of BB&T Securities, LLC. Mutual fund products are advised by Sterling Capital Management, LLC.
While this information is believed to be accurate, SunTrust Banks, Inc., now Truist Financial Corporation, including its affiliates, does not guarantee the accuracy, completeness or timeliness of, or otherwise endorse these analyses or market data.
The opinions and information contained herein have been obtained or derived from sources believed to be reliable, but Truist Financial Corporation makes no representation or guarantee as to their timeliness, accuracy or completeness or for their fitness for any particular purpose. The information contained herein does not purport to be a complete analysis of any security, company, or industry involved. This material is not to be construed as an offer to sell or a solicitation of an offer to buy any security.
Opinions and information expressed herein are subject to change without notice. STIS and/or its affiliates, including your Advisor, may have issued materials that are inconsistent with or may reach different conclusions than those represented in this commentary, and all opinions and information are believed to be reflective of judgments and opinions as of the date that material was originally published. STIS is under no obligation to ensure that other materials are brought to the attention of any recipient of this commentary.
Truist personnel are not permitted to give legal or tax advice.
Investments involve risk and an investor may incur either profits or losses. Past performance should not be taken as an indication or guarantee of future performance.
STIS/STAS shall accept no liability for any loss arising from the use of this material, nor shall STIS/STAS treat any recipient of this material as a customer or client simply by virtue of the receipt of this material.
The information herein is for persons residing in the United States of America only and is not intended for any person in any other jurisdiction.
Investors may be prohibited in certain states from purchasing some over-the-counter securities mentioned herein.
The information contained in this material is produced and copyrighted by Truist Financial Corporation and any unauthorized use, duplication, redistribution or disclosure is prohibited by law.
STIS/STAS’s officers, employees, agents and/or affiliates may have positions in securities, options, rights, or warrants mentioned or discussed in this material.
Asset classes are represented by the following indexes. An investment cannot be made directly into an index.
S&P 500 Index is comprised of 500 widely-held securities considered to be representative of the stock market in general.
Investing in commodities is speculative and involves a high degree of risk and not suitable for all investors. You could lose all or a substantial portion of your investment.
©2020 Truist Financial Corporation. BB&T, SunTrust®, the SunTrust logo, and Truist are service marks of Truist Financial Corporation. All rights reserved