Saudi Oil-Price Blunder: Tipping Point for a Global Depression
Saudi Arabia has repeated the blunder it made in November 2014 by increasing oil production during an oil-price collapse. In 2014, it led to a depression in the oil industry. This time, it may be the tipping point for a global economic depression.
On Saturday March 7, discussions between Saudi Arabia and Russia ended with no agreement to cut production. On Sunday, Saudi Arabia announced price cuts and its intention to boost production. The largest single-day fall in oil prices occurred the next day (Figure 1).
Source: Quandl and Labyrinth Consulting Services, Inc.
Things were not looking good for oil prices before then. Prices had peaked in early January with the assassination of Iranian General Soleimani, the announcement of a U.S. – China trade agreement and an OPEC+ production cut. As I wrote in late December, the price rally was doomed because it was based on sentiment and not market fundamentals.
Then the Coronavirus outbreak became public. I wrote in early February that Coronavirus would crush oil prices. It did. The Saudi price cut in March compounded and accelerated the collapse of oil prices and of broader markets.
Why It Happened
Mohammed bin Salman (MBS), the Crown Prince of Saudi Arabia delivered an ultimatum to Vladimir Putin, the president of Russia, to cut oil production on his terms. Mr. Putin doesn’t accept ultimatums so he ignored it. MBS cut prices and announced a production increase.
The events of the past week were an axiomatic response by Saudi Arabia taken from earlier playbooks. Between 1981 and 1985, the Saudis cut their production by 6.8 mmb/d hoping to stop the decline of oil prices in the face of new supply from the North Sea, Siberia and Mexico (Figure 2). King Fahd got tired of cutting without much help from OPEC allies and with no resulting price relief. He fired oil minister Ahmed Yamani, cut prices and increased production.
Source: EIA, BP and Labyrinth Consulting Services, Inc.
In 2014, world oil prices were again collapsing. Saudi oil minister Ali al Naimi asked Russia to join OPEC in cutting production. Russia refused. Saudi Arabia cut prices and increased production. See the pattern?
The guiding principle of Saudi oil strategy over the last three decades has been to never again make the mistake it made by cutting production alone in the early 1980s. Analysts and journalists who say that there is a price war or a war on shale should study history instead of inventing mindless memes.
Global Depression
“The coronavirus epidemic will lead to “a global recession of a magnitude that has not been experienced before.”
Li Edelkoort
The prolonged hiatus in economic activity particularly in the United States and China makes a global depression practically unavoidable.
Energy is the economy and most of the world’s energy comes from oil. The present devaluation of oil will spread to other commodities and currency. Although oil-price devaluation was inevitable because of coronavirus, the recent Saudi price cut and production increase have accelerated and compounded its effect on the global economy. It may become a Lehman moment.
GDP will fall as less oil is consumed. That is empirical–GDP and oil consumption have an R2 correlation of 0.96 (Figure 3). What may not be well understood is how much the U.S. and China dominate this relationship.
Figure 3 shows two charts using the same data. The graph on the left has logarithmic scales and the graph on the right has cartesian scales.
The graph on the left has logarithmic scale and the graph on the right has cartesian scales.
Source: EIA, World Bank and Labyrinth Consulting Services, Inc.
The left-hand graph shows the correlation. The right hand graph shows the disproportionate weighting of China and the US on both GDP and oil use. Together, they account for 32% of world GDP and 34% of oil consumption.
China’s oil consumption is probably down 4 mmb/d for the first quarter of 2020. If it returns to normal by Q2 (unlikely), that implies ~1% drop in annual global GDP. Things won’t normalize in China and the U.S. contraction will compound lower consumption well beyond Q1 not to mention lower consumption in the rest of the world. There are lots of reasonable objections to using this correlation deterministically but it offers a high-level perspective about where the economy is probably going. That’s why it is difficult to imagine an outcome other than depression.
“The last time that there was a global surplus of this magnitude was never“
There will be a lag between falling prices and demand, and a corresponding decrease in production. Meanwhile, inventories will build and some expect that global storage capacity will be exhausted by summer. Is that reasonable?
Figure 4 shows the accumulation of comparative inventory accompanying the last oil price collapse in 2014. 5 months elapsed from the beginning of price decline until C.I. reached the 5-year average. It was another 18 months before peak storage and minimum price were reached. Despite analyst expectations, neither U.S. nor global storage capacity were filled.
Source: EIA and Labyrinth Consulting Services, Inc.
Comparative inventory is just below the 5-year average currently. Assuming a similar rapid fill rate, maximum storage levels would not be reached until July 2021. Today’s WTI settle price of $28.70 is almost as low as the minimum level reached 4 years ago suggesting that price may have much farther to fall before finding a bottom.
It seems unlikely that the virus will be contained before the second half of 2020 at the earliest. That is why I expect an economic depression and oil-prices of $20 or lower before long.
Tipping Point
When the normal spread of a disease transforms into an epidemic, it is called a tipping point. It is that moment when a small change tips the balance of a system and brings about a large change.
We are there. I’m not talking about coronavirus. I’m talking about the tipping point of our civilization.
Humans have not evolved emotionally since hunter-gatherer times on the African savanna. We believe that the planet’s space and resources are ours to use however we want regardless of implications for the earth and its other species.
We have developed an economic system that values economic growth above all else. Oil, more than any other factor, has super-charged our economic growth over the last century. When growth began to slow as oil became more expensive, we turned to debt, a call on some future energy surplus. The Financial Collapse of 2008 was a signal that we needed to de-leverage our debt. Instead, we devised clever ways of papering over the debt problem with more debt.
Now, the coronavirus has abruptly stopped the machinery of growth. Contagion–man’s primordial fear–is spreading. Markets are collapsing and there are no solutions in sight. The most social of species is facing isolation.
We have crossed a threshold. It cannot be successfully crossed in fear. The virus will pass and this is not the end of times. Still, things will not return to the way they were before the tipping point was reached. We must finally seek balance with each other and with the planet, and, hopefully learn to live with less.
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[…] Saudi Prince took the bizarre step of launching a price war on petroleum against the Russians: “Saudi oil-price blunder: Tipping point for a global depression.”# Berman later elaborated, a month later, “Game over for oil; the economy is […]
Michael,
Every country deserves the government it has. That does not, however, mean that we have no expectation of leadership just because we elect jerks to run our countries. I think that Trump has done a miserable job of leading on oil and I did not vote for him. Nonetheless, I expected more from him–not much more–when OPEC+ decided not to cut production.
Best,
Art
Until a bottom or at least an inflection is discovered, I don’t think anyone can answer your question. It will be interesting to see how much demand recovers once the economic closure is over. I doubt there will be a return to 2018 levels of price or production but that’s just my sense. The longer this goes on, the less likely things are to ever revert.
Best,
Art
[…] particularly in the United States and China makes a global depression practically unavoidable,” said the highly respected Houston oil analyst Art Berman on his popular […]
We have reached that tipping point you pointed out back in 2014 when I 1st started following your very informative work. Will be interesting to see where we land from here. Wish I was better equipped health wise for the coming fallout. Regards, and thank you again for your work and for sharing this vital work & relationships.
Thanks Art.
I always find your articles highly informative, this one especially so. I qualified in Geology as we were turbo-charging our economies (national & personal) with debt as you elegantly put it. I have always had a dislike of debt, so by saving, my smallish, houses are paid off, and I have enough money to see out the year (the children are all off the payroll).
Most folks we know are deeply in debt, but still buy their kids the latest iphones, etc. I agree the c-virus is a game-changer..
In the ‘patch’ we are also burning through our reserves and not replenishing them. Surely Wall St will eventually want higher prices to recoup their investments (as well the the potential for unrest in the petro-states).
Sorry for the digression, here’s my question.
When do you see exploration picking up again ?
PS. All I want is 2 more good years and it’s ‘auf wiedersehen’.
Great content as always Art. The fact it’s free is a gift. Excited to be a member of your paid service when it is up and running.
Stuart,
Thanks. I think that we are up & running (fingers crossed).
Best,
Art
I salute you Art. And the comments after Tipping Point were priceless. It’s possible that Corona passes more quickly and the financial system will be saved – yet again. But we will all be better off to “seek the balance with each other and with the planet” that you so eloquently have written.
Tom,
I hope that coronavirus passes more quickly than I fear. Still, humans only change with extreme trauma. Clearly, 2008 was insufficient. What will it take?
Best,
Art
Art, just curious as to what level of demand destruction you think covid 19 is creating in the oil markets?
Tom,
Estimates from Vitol, Trafigura and Goldman Sachs range from 8 to 11.4 mmb/d.
Best,
Art
Your statements would make more sense if they talked about US oil production.
The US as a large net consumer is very different than the US as a relatively self sufficient entity. The impact of this disappeared US oil demand on oil prices would seem to be significant – admittedly, that the US has always imported most of its oil from Canada and Mexico.
In any case, thank you for responding to my honest inquiry with disdain and condescension.
I simply pointed out that your comments were largely irrelevant to my post & based on memes rather than data.
You are entitled to your opinion of my work and comments. I am likewise entitled to mine.
I wrote a post based on what I considered important to understanding the recent conflict between Saudi Arabia and Russia. If you want to write a post about why U.S. production is important to that subject, go ahead.
We need to admit that the politicians are us. They are not some sort of separate species. Politicians have been elected because of who we are, not because of who they are. They are elected because people “think” like they do. The political establishment does not lead. It is a manifestation of the sentiment, values and beliefs of the American people. The mirror does not lie.
Critical thinking is required. What makes you think that SA was trying to hurt US fracking in 2014? Mindless memes by ignorant people provided that dumb explanation. What does China have to do with my post? You see a connection but I don’t or would have mentioned China.
Nothing is ever different this time but people always think it is. Silly people.
All the best,
Art
Indeed, Matt. Shale represents the most desperate effort to continue exploiting diminishing natural resources at any cost.
Best,
Art
What I learnt in “shale revolution” so far is that it is unsustainable business with bad environmental impact. We are now experiencing 2nd bankruptcy wave in span of just 6 years with total costs of of both waves probably well over 300 billion (you probably kow the correct number). Nat taking in account enviromental impact and considering that on average it created more than 1 million jobs/year net impact for economy was positive. However investors lost the money.
Once price will go above 50 (12-18month?), do you think that there still will be willing investors to finance another round of shale ?
Peet,
I don’t believe that anyone knows what the world will be like on the other side of CoV economic closure. Hard to apply rules from before.
Best,
Art
Daniel,
People will listen when they are ready. That usually means after great trauma.
Best,
Art
David,
When I say $30 oil, I don’t mean a daily price but a monthly average. So far, the March average is $36. It is fair to say that markets are clearly in panic mode so that estimate seems to hold for now.
All the best,
Art
Alexander,
What you say is true. I especially agree with the part about the problem being ourselves. I cannot follow you to the next step in your logic to then, blame the problem on politicians. That seems to be a convenient way NOT to accept that the problem is us.
All the best,
Art
Scott,
I’m afraid I missed a lot of what you said because of typos and lack of punctuation–that’s not a criticism, just the truth that I really don’t understand your point. Would you mind writing it clearly so I can understand?
Thanks,
Art
Your message isn’t very clear.
The Saudis tried to stall the US oil fracking industry in 2014 – that failed because China was still seen as a growth engine, thus a driver for higher consumption.
The same cannot be said for today. Furthermore, unlike 2014, the US now derives significant economic value from oil production.
Driving oil prices into the ground should be seen as an economic impetus for China, not necessarily the US.
So it seems things are different this time around.
I agree with your analysis, but didn’t know if you before. I am THE founding Oil Analyst at FirstEnergy Capital Corp with Murray Edwards and Brett Wilson. I’ve been arguing for a global OPEC including Canada and the US when they elect a progressive it’s an element solution if done right tying carbon price, oil price and heat rat for gas to drive consumers to EV’s and meet the Paris climate objective. I was unable to get the press in Calgary to Even discuss the issue cause they are bought and paid for by former friends and business acquaintances I followed Opec closely during my Career and believe the US behind all oil prices movements except this one.
Wise concluding words. And shale oil has allowed the system to more or less continue business as usual, making the problem now bigger than it was in 2008/09
I shared and often referenced your July 2016 article on why oil prices may never recover. So I couldn’t help but notice that article and this one end with the same line. When will people start to listen?
But Art you said in your March 3rd post that you
could see a scenario of oil prices $30 to 40 in a
panic situation but would probably be unsustainable for long.
You said prices should go back to low to mid 50’s eventually.
What has made you change your tune so much now?
Much more bearish. Do you still see low to mid 50’s and how long?
I wholeheartedly agree. However the monster standing before us is ourselves. We destroyed the natural world and our unnatural world will quickly follow. Without a dismissal of career politicians who run the country for the few and a huge reduction in population growth we face destruction.