What happens when a global health crisis leads to fewer airline flights, a contraction in industrial activity, and basketball teams playing in empty arenas? The demand for oil goes down. Now quick, you economics majors, what happens to the price of a commodity when demand decreases? If you said, “It goes down,” go to the head of the class.
Last week, the nations that make up the Organization of Petroleum Exporting Countries met to craft a response to the coronavirus pandemic in hopes of keeping the price of oil for falling. They failed, primarily because Russia refused to cut its production as requested, according to a report by CNBC.
After the talks collapsed, Edward Bell, a commodities analyst at Emirates NBD, penned a research note to his clients that read, “Members look now to be preparing for a price war by announcing plans to actually increase output. The outcome is an astonishing reversal of what appeared to be a pending production cut to compensate for the decline in demand caused by the Covid19 outbreak.”
The existing production agreement between the OPEC countries expires at the end of March. After that, the member states can pump as much oil as their little hearts desire, but more oil and lower demand seem to indicate oil prices could take a tumble. Already the price of Brent crude is down 9% to $45.27 while US West Texas Intermediate sank more than 10% lower to $41.28, its lowest level since 2016. That led one industry observer to tweet this rather startling prediction. Khedery was Exxon’s senior Middle East adviser before becoming CEO of Dragoman Ventures, which is based in the US.
$20 oil in 2020 is coming. Huge geopolitical implications. Timely stimulus for net consumers. Catastrophic for failed/failing petro-kleptocracies Iraq, Iran, etc – may prove existential 1-2 punch when paired with COVID19. https://t.co/cw5uzDz8Yx
— Ali Khedery (@alikhedery) March 7, 2020
At emergency talks in Vienna, OPEC said it would reduce output by a million barrels a day if Russia would cut its production by half a million barrels a day. Russia said “Nyet.” Russian energy minister Alexander Novak told the press after the meeting, “As from 1 April we are starting to work without minding the quotas or reductions which were in place earlier but this does not mean that each country would not monitor and analyze market developments.”
Industry analysts at Goldman Sachs are worried the coronavirus could depress demand for oil throughout 2020. According to The Guardian, they believe oil prices were only likely to average $45 a barrel in the first half of this year even if a production cut had been agreed to because it would not be enough to offset the impact of the virus on China’s economy. Many of China’s largest refineries and factories have shut down as a result of the virus.
Jeff Currie, the head of global commodities research at Goldman Sachs, tells The Guardian, “The damage is done. The demand damage is happening today, right now. Cutting production by 1.5 million barrels a day in April or May is not really going to save you in the current environment. That’s why I say it’s too little too late.”
Political Implications & Beyond
Many oil-producing nations depend on income from oil to survive. A significant decline in revenue could destabilize them politically. Countries like Iran and Iraq are in jeopardy, but so are Venezuela and Brazil. Russia reportedly is heavily dependent on oil revenue to prop up its creaky economy. Think what the consequences of political instability in Russia might be.
Low oil prices also will put pressure on expensive extraction techniques such as fracking and obtaining oil from tar sands. That could impact the pipeline business if there is less oil to transport. Less production will certainly benefit the environment as there will be fewer carbon emissions spewing into the atmosphere if less oil is consumed.
On the other hand, lower gas prices may further invigorate the sale of humongous vehicles like pickup trucks and super sized SUVs, which could put a damper on the electric vehicle revolution and increase tailpipe emissions, particularly in the US.
No one knows as of this moment what the full impact of the coronavirus will be on the global economy but with each passing day the news gets bleaker. Just like the global economic disaster 12 years ago, the full extent of the catastrophe may not be known for many months or even years. The only positive is that the oil industry may never recover from weak demand and depressed prices, which may create market opportunities for 21st century technologies to replace the world’s economic dependence on oil.