IHS Markit: Oil price war in the time of coronavirus

Oil markets are now facing an unprecedented double shock—a demand crisis and price/market share war—that will likely push crude prices to multi-decade lows. In the short term, this likely means prices revisiting the 2016 and 2008 lows.

According to Roger Diwan, vice president of financial services, IHS Markit, demand not only has to rebound from the coronavirus shock, it will also now depend on the course of the price war and the stamina of Saudi Arabia and its OPEC partners in the face of collapsing revenues.

Demand crisis of uncertain (but sizeable) proportions provides the worst possible backdrop for a price war. Moreover, there remains significant uncertainty around the extent of the demand damage to come. “The aggressive containment measures adopted by the Italian government in the Northern provinces over the weekend are a taste of what could still come should the rate of contagion accelerate across Europe and North America (as appears likely). As things stand, global demand appears likely to contract materially y-o-y for the second quarter in a row, with the main question remaining whether it is a 0.5-1 million b/d drop or a 2+ million b/d drop,” Roger Diwan said.

“Saudi Arabia’s answer to the breakdown of the Vienna Alliance on Friday was swift, making it known that it is preparing to hike output to as high as 12 million b/d in the months ahead if it finds takers for its discounted barrels.”

Aramco’s OSPs are fixed monthly differentials to their respective regional crude benchmarks. The proposed differentials for April were staggering, with OSPs slashed between $5-8/bbl in the largest month-on-month revision in recent memory. Cuts went across the board but were particularly acute in the Atlantic basin, with OSPs to Europe and the US slashed $7/bbl or more, clearly aimed at key Russian markets.

“It’s not “if” stocks will build significantly, it’s by how much," IHS Markit said. Markets are now facing a severely oversupplied market in this year's second quarter with two uncertain dimensions, the trajectory of demand and the extent to which Saudi Arabia and its Gulf partners are willing to flood markets and allow for very large stockbuilds.

“Markets face a 1-2 million b/d potential downside swing in demand (depending on the severity of COVID-19) and 1-2 million b/d potential upside swing on supply. This represents an enormous confidence interval, and the difference between catastrophically oversupplied (4-6 quarters to unwind) and manageably oversupplied (1-2 quarters to unwind). It’s too early to tell which way balances are trending but the next 2 weeks will likely provide significant input into that trajectory. In the meantime, very few courageous souls will be willing to hold long positions,” Roger Diwan said.

Russia, Saudi Arabia, and US shale are entering a low-cost producer deathmatch, IHS Markit said. While Russia and Saudi Arabia’s strategic misalignment was the trigger for this next supply shakeout, US E&Ps will very much be at the receiving end of the price collapse. With WTI prices already trading around $30/bbl in early trading on Mar. 9, the industry will need to react swiftly and decisively in the face of the acute decline in cash flow. The shift to sizeable sequential declines will not be instantaneous, but at these prices, are likely to come by the third quarter, and will be severe through the end of 2020 and 2021. It will also be bruising for Saudi Arabia and Russia, who will see plummeting government revenues.

Saudi Arabia’s aspiration appears to be that the supply damage wrought in the US and pain caused elsewhere will be sufficient to bring other producers back to the negotiating table in short order.