When And How Will Oil Prices Recover?

No, I am not going to predict the path of the pandemic, either it’s severity or its end. There is certainly evidence suggesting that social distancing and frequent hand-washing are very useful in limiting the spread, and the recovery of activity in China is definitely a hopeful sign. That said, the global oil surplus is about both the demand paralyzation (I would argue it’s not being destroyed, just frozen) and the price war between Russia and Saudi Arabia. After all, before the pandemic began, the market was in surplus and prices were weak, and the roughly 2.5 mb/d increase from those two producers magnified the glut.

In the 1998 oil price collapse, non-OPEC production dropped by about 1 mb/d as the figure shows, which was not enough to restore prices. This time, the physical nature of shale oil production should result in a stronger decline, given the rapid decline in production, especially from new wells. The financial condition of many producers would almost certainly mean that the small companies will see drastically reduced investment, but because they’re small, the impact on production levels will not be overwhelming.

But even if non-OPEC oil production drops by 2.5 mb/d by the end of the year, which would probably require prices remaining below $30/barrel, that would only restore global production to pre-covid19 and pre-price war levels. By that time, hundreds of millions of barrels will have been added to storage and using that up will be a Herculean (or Melqartian, if you’re Phoenician) task. Meaning without some resolution of the struggle between Russia and Saudi Arabia, prices will remain depressed, conceivably about $30, for a lengthy period, months or years.

The question remains: What is the Russian goal? If it is merely to punish the U.S. for its economic sanctions, then expect the price war to last for months, but recovery when the U.S. makes some peace offering (especially reduced sanctions) or, worst case, after the November election.

If Russia wants to force the Saudis and other OPEC members to bear the entire burden of price stabilization, or at least the covid19-related reduction, then some face-saving measure that satisfies the Saudis and results in them making a severe, albeit short-lived, reduction. This could happen at any time, certainly the June OPEC meeting being target of opportunity.

At least one Texas Railroad Commission member has suggested that Texas might force its producers to prorate their production, perhaps reducing it by 10% which would be over 500 tb/d, perhaps twice that if other members of the Interstate Oil and Gas Compact Commission follow Texas’ lead. However, the Commission Chairman has said he opposed such a move and Ryan Sitton, who floated the idea, has been defeated in the primary election and will not serve much longer.

Finally, if Russia was concerned that oil prices were unsustainably high, the implication would be that an agreement would be difficult to reach, there being no indication that Saudi Arabia agrees. And even on reaching an agreement, prices would almost certainly remain lower than pre-price war levels, possibly below $50 for years. At a minimum, the goal would be to cause shale oil production to flatten out and maybe decline, in order to make room for growing production from Russia, Iraq, Brazil, and eventually Iran and Venezuela.

This is hardly good news for the U.S. oil industry (and many others), but the basic reality is that, even with over 5 mb/d of oil production shut in by political disruptions, the market was oversupplied even before the covid19 pandemic. While there might be a brief surge in oil demand after the pandemic is brought under control, even the best case does not result in a balanced market without continued cutbacks from OPEC+.