Energex musings on recent global events

Energex musings on recent global events

Published on March 13, 2020

We are taught as children that every action has a consequence and experience tells us that many an action can have unintended consequences. There can be few examples of unintended consequences that could trump those that are consequent upon the recent debacle that masqueraded as an OPEC+ gathering!

That any sane observer can be persuaded to suspend belief and buy in to the thesis that some grand geopolitical plot was successfully promulgated by Saudi Arabia and Russia to punish the USA for gluttonous overproduction of crude oil, defies rational conception.

Yet weighty commentators and journals have, in recent days, been suggesting just that. According to the thesis, Igor Sechin sent his envoy to the talks to refuse to cut production in order to take a swipe at the USA for recent sanctions widening which again targeted Rosneft. He could not have envisaged how seemingly successful his strategy quickly became when, in what must be reckoned as a fit of petulance, Saudi Arabia abandoned disciplines that have, on the whole, survived the last 30 or so years.

There have been many markets savants who have been predicting that only a serious geopolitical crisis could force the oil price out of its $50-$70 band, yet none would have wagered on such a breakout occurring downwards.

Yet “seemingly successful” may be a gross exaggeration. US oil producers, indebted and starved of further funding as we know they are, have, in many cases at least some hedge cover through 2020 (recent estimates suggest at least 40% of production is covered, although the type of hedging structure common in US domestic markets may provide only partial downside coverage). For Russia and Saudi however, there will be no hedge cover at all. In such circumstances the bare economics of Russia’s decision not to cut production by 300,000 b/d suggests a reduction in income of $35 billion over the rest of 2020 (assuming a $20 reduction in oil price and a 6,000,000 b/d export level) versus the $4 billion loss that would have ensued from the cut!

The pain is likely to be felt more across the other less fiscally conservative members of OPEC and Non-OPEC. There are some instances -well documented-of Sovereign producer hedging (Mexico, Egypt, Qatar et al), but they are notable by the paucity of examples. At the same time, US domestic producer hedging has been a booming business for risk management liquidity providers for many years. So some of them might well be “(almost) all right Jack” – for now!

In this environment it is likely that the potential post hedged calamity that is now seen to be approaching down the road to the Permian will accelerate the inevitable further consolidation of the remnants of the wildcat – like oil shale industry structure into stronger (household name) arms, thus further undermining any significant impact of all out Russian and Saudi production on the USA.

Traders skimming the cream from the volatility may largely enjoy these weeks (there will always though be some losers exposed to spikes in volatility and to the downside) and with books having been more than likely adjusted to prepare for virus downside risk, most will have been well positioned for the dramatic downside price action. There are no rumours of catastrophic losses circulating amongst the market players in what, these days, is a small transparent milieu.

If traders are likely to be (largely) winners, who else might be rejoicing in the misery of collapsing markets and global pandemics? Not the airlines for sure but likely the sea freighters – both Wet and Dry – and also Marine Diesel and VLSFO markets. What of gasoline? With travel embargoes likely to affect air transport more than road transport, there could be interesting gas / jet price differential action to come as jet fuel demand collapses more than gasoline demand. The storage providers will be happy as will LNG purchasers with oil-linked formulae. Will IMO 2020 take a back seat for now and will the renewables clamour cool – at least temporarily?

Much will depend on timing of course – both virus and increased production. The former may well be easier to assess from a time frame perspective if, as in China, lock down in Italy leads to a falling number of new infections over the same sort of time scale. Markets will then be able to get a handle on how long the overall demand disruption might last in a more rigorous, less speculative way. The latter will require either the Saudis or Putin/Sechin to lose face. That neither may be prepared to do so voluntarily suggests that a word from Trump in a certain Crown Prince’s ear may be the best hope of a move back to normality and that may, in a US election year, with voting around the time that hedges will start to run out, be a not unreasonable scenario to believe in.

Yet a new die has been cast and even if Trump gets well in front of the political threat to his re-election that the Russian and Saudi eruptions (combined with an only somewhat ameliorated effect on US production through partial hedging) have visited on him, the sense of stability within a range, that has pervaded oil market price opinion in recent years is gone for the foreseeable future and enhanced volatility is likely to be around for a while.