Energy Markets Update – Implications of the Russia-Saudi Tensions

There are several implications for consideration, which we discuss below:

Russia. It was reported that Russia refused Saudi Arabia’s suggestion of deeper cuts to put a floor in oil prices. Russia’s refusal could be seen as a tactical play at hurting U.S. shale producers who have benefited from higher oil prices and production in recent years. Oil price at current levels will likely make many of the U.S. shale producers loss making and will also limit their ability to get financing. However, we note that OPEC has in the past tried to hurt U.S. shale producers with lower oil prices, but the sector was able to come through by being more efficient. Further, there are suggestions Saudi Arabia is trying to shock oil markets in the hope it will drive Russia back to the negotiation table. However, Russia can sustain lower oil prices for much longer than Saudi Arabia and some of the other Gulf nations.

Saudi Arabia. Saudi Arabia is the lowest cost producer in the world – less than US$5/bbl. However, Saudi Arabia’s budget breakeven oil price is US$83.60/bbl versus Russia at US$42/bbl and significantly higher than U.S. shale producers. Lower oil prices hurt Saudi Arabia at a time when it is trying to make significant investments in other parts of its economy to reduce its exposure to oil.

Lower oil prices not necessarily good for the U.S.Lower oil prices in the past has been a positive for the U.S. consumer. However, the current situation is such that any likely demand pick-up from lower oil price will be relatively contained due to the demand destruction from the Coronavirus. From a political perspective, the hit to employment – both directly employed by the U.S. shale industry plus contractors & suppliers to shale oil projects (that is, reduced or discontinued capital expenditure plans) – could be key in the upcoming U.S. election. The breakeven price for U.S. Permian basin producers is also at similar levels to Russia at US$42/bbl. However, unlike sovereigns, companies cannot run budget deficits and credit markets could seize up if the oil price stays below these levels for an extended period of time.