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Trump's Oil Deal is Here. All you Need to Know

April 10, 2020

 

The global economy, which has been grappling with the ongoing COVID-19 pandemic, is also currently facing an oil price war, with prices of crude oil crashing in the global market. Here’s delineating the rundown to the battle to set oil prices.

 

The Organisation of the Petroleum Exporting Countries (OPEC) is a permanent intergovernmental cartel organisation established in 1960, whose objective is “to coordinate and unify petroleum policies among Member Countries, in order to secure fair and stable prices for petroleum producers; an efficient, economic and regular supply of petroleum to consuming nations; and a fair return on capital to those investing in the industry.” Russia had joined forces with OPEC in 2016, along with nine other non-member countries. Since then, the group has controlled almost half of the world’s oil production. The newly formed “OPEC+” pact led to a resurgence of the cartel, which wields immense power over the world’s most critical and volatile commodity.

 

This year, the International Energy Agency (IEA) has scaled down the global demand for oil, a move not taken by the energy watchdog since 2009, since the demand for oil had already weakened owing to the global economic slowdown, as well as further pronounced by the COVID-19 pandemic, which has hit China’s economy and reduced consumption by the world’s largest importer.

 

The recent dwindle in oil prices has been characterized as a direct consequence of the dramatic collapse of the alliance between Russia and the OPEC nations last month. The price of oil plunged more than 50% in the days after the bust-up and then began to swing violently, causing tremors through a global economy already wobbling from the fallout of the coronavirus pandemic. At the onset of April, speculations of an unprecedented global production cut have been made.

 

 

Headquartered at Vienna, Austria, the OPEC+ last convened on 6th March when Russia refused to go along with production cuts pushed by Saudi Arabia - OPEC’s largest producer of crude oil and a lynchpin driving force. The kingdom wanted to trim output further to prop up prices as the coronavirus ravaged demand. After the fallout with Russia, Saudi Arabia responded aggressively just hours later, reversing course and ‘opening the taps’. Russia’s decision to reject any production cuts is driven directly by its aim of denying market share to American shale oil producers. The U.S., as the largest producer of crude oil and gas (shale) today, has stayed away from the OPEC+ alliance, hoping that production cuts by OPEC+ countries will help it increase its market share.

 

The ongoing stretch of the pandemic is estimated to reduce the demand for energy manifolds. The slump in prices has threatened the livelihood of millions and the economic, political stability of many oil-dependent nations. The energy war over prices is being deemed as Russia’s revenge as the American shale oil industry cripples. President of the United States Donald Trump has managed to put together a rescue package for the shale oil companies in America and on 2nd April, called for a coordinated production cut. Canada has also expressed its displeasure at the “predatory dumping by unfriendly dictatorships that are seeking to drive North American energy producers out of business” through the means of the cripplingly low oil prices and tanking demand.

 

Russia’s retaliation towards OPEC is precedent since it no longer wanted to be sweet-talked into reducing its lucrative oil production and evidently sees the OPEC deal as a shelter for the American shale oil industry. This move further aims to signal to Saudi Arabia that the United States can’t always protect its oil interests and the prudent idea for the kingdom would be to engage with Russia towards an agreement. Another factor that is at play here, is Russia’s resentment over the restrictions imposed on Russian energy company Rosneft which is building the gas pipeline project Nord Stream 2 across the Baltic Sea, carrying Siberian gas to Germany which is a major consumer. Moscow has accused Washington of using geopolitical tools of sanctions to prevent the completion of the pipeline.

 

Lower oil prices are not necessarily disadvantageous for oil-importing countries, such as India, which is the world’s third-largest importer of crude oil.  There are, however, other adverse consequences like the battering of the stock markets in the international economy. The global economy, already impacted by the United States’s trade war with China and other countries, including India, and the COVID-19 pandemic, may find lower energy costs helpful in certain aspects pertaining to overall growth issues. But these may further be countered by the slackening demand. Winners from the rock-bottom prices include China - the largest importer for crude oil, however, such a dramatic crash in the price of oil is also expected to savage national budgets of petro-states such as Venezuela, Nigeria and Iran, threatening to shake-up the politics around the world. To policymakers, volatile oil prices are an added complication as they try to immunise their economies from facing the brunt of the coronavirus epidemic.

 

Further, Carlos Pascual of the IHS Markit consultancy says, that even with the possible truce in the price war, the deamn side is expected to make recovery difficult for a long time. In his assessment, Pascual mentions that the Brazilian pre-salt market, on the contrary, has the advantage of low enough costs to manage the crisis. It can be noted that during the last oil crisis between 2014 and 2016, there was a requirement of more than 18 months for the stocks to be recalled into the market. 

 

 

Further, Carlos Pascual of the IHS Markit consultancy says, that even with the possible truce in the price war, the demand side is expected to make recovery difficult for a long time. In his assessment, Pascual mentions that the Brazilian pre-salt market, on the contrary, has the advantage of low enough costs to manage the crisis. It can be noted that during the last oil crisis between 2014 and 2016, there was a requirement of more than 18 months for the stocks to be recalled into the market.

 

Hence, it is important for the global leaders to reach common ground regarding the reduction in production which can prove instrumental in reducing the issue of the piled-up oversupply.

 

On 12th April, nudged by the United States, Russia and the OPEC nations have managed to concatenate and agreed to cut production. A move that has been hailed as an unprecedented effort to coordinate by Russia, aims to stabilize the crashing oil prices and bring some stability to the global financial markets that are enduring an economic slump. The OPEC+ will slash production by 9.7 million barrels a day in May and June, or close to 10 percent of the world’s output.

 

The rushed move comes at a time when the global benchmark plunged to its lowest in nearly two decades, falling toward $20 a barrel. Earlier this year, it traded above $70 a barrel.

 

According to the NY Times, the deal between Saudi Arabia and Russia was catalyzed by US President Donald Trump, owing to the setback being faced by the American shale companies and a falling economy. President Trump is also facing a re-election campaign this year. “It was unclear, however, whether the cuts would be enough to bolster prices. Before the Coronavirus crisis, 100 million barrels of oil each day fueled global commerce, but demand is down about 35 percent.“Demand is down by more than double the 9.7 million barrels-a-day cut agreed,” said Amrita Sen, chief oil analyst at consultant Energy Aspects Ltd. While significant, the cuts agreed to on Sunday still fall far short of what is needed to bring oil production in line with demand”, it further said.

 

The cut imposed is slightly less than the earlier discussed levels, but seems to be promising some relief to the oil-dependent nations in the Middle East and Africa as well as the United States shale oil companies, as Trump notified in his Tweet late Sunday, “...this (the deal) will save hundreds of thousands of energy jobs in the United States.”

 

However, stalling production to a staggering extent will have negative repercussions - both economically and technically. When companies continue to produce in a period of oversupply, the price of oil continues to weaken, and the companies with the most uneconomic deposits start to flounder. However, if production cuts are rapid, the pressure building in the oil wells can diffuse to other areas, and make future extraction both unviable and time-consuming.

 

The global economy’s response and revival, with many variables and uncertainties factored in, in view of the COVID-19 shocks, remains to be seen.

 

References

 

The post has been updated to reflect latest events. Views expressed are solely those of the author.

 

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About the Author

Bhavya Pandey is a student of Economics at Daulat Ram College, University of Delhi. A voracious reader and declamatory writer, she has grown up exploring and opining on a plethora of subjects ranging from environment to economics. She is a trained Indian classical dancer in Kuchipudi, under the tutelage of Padmabhushan Gurus Raja Radha Reddy and has been performing for more than a decade. Bhavya enjoys penning down poetry besides affixing a monocle and combing library bookshelves in search of classics in her free time. She is also currently serving as the Joint Secretary for the Women’s Development Centre of Daulat Ram College and editing for three collegiate level magazines. Bhavya can have endless conversations about the internet and food.

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