Oil prices fell by 30% to $27.71 a barrel following news that Saudi Arabia will increase production and offer discounted prices to compete with Russia.
Russia has abandoned the Opec+ alliance, refusing to cut down oil production due to the coronavirus outbreak in Saudi Arabia. Saudi Arabia planned to reduce oil production in order to support crude prices due to the outbreak and the disruption it caused to economic activity, something which makes sense considering how far oil prices have fallen.
Riyadh’s response was to raise crude oil production and offer it at steep discounts as a punishment to Russia. This drove the oil market into a frenzy, panicking investors who initiated a sell-off, driving crude oil prices to new lows of $27.71 a barrel.
It is very likely that oil demand will drive prices even lower as cities and whole countries, such as Italy, are currently on lockdown. Demand for oil is expected to decrease due to the outbreak as cases are rising by the hundreds daily around the world, initiating lockdowns and halting public transport.
As long as the price war between Saudi Arabia and Russia continues the oil market will not recover, which raises questions as to why Russia refuses to reduce production.
Russia is aiming to reduce US shale production, fluctuating junk bonds and making individual consumers the winners of the oil price war.
Russia wanted to wait longer in order to witness the full impact of the coronavirus outbreak before making a decision on oil production. However, the impact could already be seen in many countries, such as China, Italy and South Korea where the cases have risen dramatically and preventative measures have already been taken.
The true motive behind Russia’s actions was to put the US shale industry under distress. This is because US shale oil has covered demand for oil so far, demand that Opec+ was unable to cover due to cutting down production.
Russia’s refusal to cut production, alongside Saudi Arabia’s production increase and discount prices, will have a big impact on the US shale industry, reducing growth in the long-term.
Even though the US shale industry production has increased, the news came as a blow for the industry, which has burnt through borrowed money.
The issue would be with shale producers who will potentially struggle to secure new financing in order to roll over their existing debts. Many junk bonds, which are rated below investment grade (BBB and below), issued by energy companies have been decreased in value as investors have lost trust in energy companies and their ability to pull through the oil price war.
Due to the massive drop in prices for crude oil and Saudi Arabia planning to offer discount prices to Europe and Asia, individual consumers will be able to fill their tanks at lower prices, making them the obvious winners at the expense of investors and energy companies.