March 16, 2020 BARRON’S 37
OTHER VOICES
Shifting oil prices shouldn’t be on
the top of most investors’ lists of
things to fear in the world.
3 Good Reasons
NottoFearan
Oil Price War
Y
es, the oil market
crashed this week.
No, this is not the
time to be scared
away from oil. Here
are three reasons be-
yond value that this
week’s drama shouldn’t frighten off
oil investors.
First, oil isn’t just a number on a
screen, but also a physical commodity
that consumers will buy with cheap
prices. With Saudi Arabia offering
discounts of $4 to $6 per barrel for
Asia, it won’t be only speculators
buying. Chinese refiners and the Chi-
nese government, as well as other
importers, will use this opportunity
to purchase large amounts of physical
oil for refining or storage. Low oil
prices over the next few months will
function essentially as a stimulus
package for a struggling Chinese
economy and will show up in reports
as higher demand numbers. This
data, in turn, will help lift oil prices.
In fact, it looks like this is Saudi
Arabia’s strategy. The kingdom low-
ers prices, increases supplies avail-
able for export, sells more to China
and other customers, and sees global
demand numbers rise. This approach
is based on the risky assumption that
the markets will react to higher de-
mand data and significantly raise oil
prices. If it plays out, this higher de-
mand will show up in data released
by early May.
Second, the current drop in oil
prices is unrelated to long-term struc-
tural weaknesses like peak demand,
alternative energy technologies, or
rising electric-vehicle use. Peak de-
mand is a theory that may prove true
some day, but it is no more likely to-
day than it was at the start of 2020,
when Brent was $66 per barrel.
If this drop in oil prices were re-
lated to a breakthrough in batteries to
store solar power or surprising sales
numbers for electric vehicles, there
would be reason to believe that low
prices may be the new normal for oil.
But neither is the case. This week’s
events are based solely on factors that
will settle themselves eventually.
Third, this week’s oil-price crash
was a unique confluence of events
that won’t be repeated. Oil is not im-
mune to the undercurrent of corona-
virus anxiety that’s affecting every
sector. But the proximate cause of the
crash was a specific chain of events
that started with a rift between the
Organization of Petroleum Exporting
Countries, the original 14-member
cartel in which Saudi Arabia holds
sway, and OPEC+, a new, extended
24-member alliance that includes
Russia. Moscow started the distur-
bance by effectively vetoing an
OPEC+ production cut proposed by
Saudi Arabia.
The friction was not new. In fact,
the tensions between Russia and
OPEC easily could have boiled over in
the summer of 2019, when Iran and
Russia fought over a date for the
OPEC+ meeting in Vienna. The entire
OPEC+ cooperation initiative seemed
on the verge of collapse again in
December 2019, when oil ministers
nearly failed to put together a new
production-cut deal. The group sur-
vived into 2020 because Saudi Arabia
offered Russia a generous exception
for its gas condensates and the Saudi
oil ministry took more of its own oil
off the market.
It was no surprise when Russia
refused to accept further cuts at the
March OPEC+ meeting. Just a few
days before the meeting, Russian
President Vladimir Putin set up his
energy minister, Alexander Novak, to
take this tough stance, saying, “For
the Russian budget, for our economy,
the current oil prices level is accept-
able.” In truth, Putin had effectively
vetoed any OPEC proposal before it
was ever made.
If last week’s fissure had happened
at one of those moments in 2019, the
market’s negative reaction would
have been tempered. Had OPEC lis-
tened to Putin the week before, it
might not have tried to push such an
aggressive production cut on Russia,
and the public divide would have
been avoided.
But that wasn’t all. After Russia
walked out of the meeting last week,
Saudi Arabia announced that it
would produce more oil and lower its
prices, especially to Asia, which it
hopes will entice China to buy more.
This policy is logical, because—so
long as assumptions hold—it should
increase Saudi sales and also improve
global demand data. After all, de-
mand anxiety has been the strongest
force keeping oil prices down the past
year.
If Saudi Arabia had increased sup-
ply and lowered prices at the end of
February when China cut its orders
of Saudi oil, the market reaction
would have been less severe. Instead,
coming immediately after Russia’s
refusal to cut and amid the coronavi-
rus fears, the new Saudi policy was
seen solely as a hostile reaction to
Russia’s actions. In other words, the
market took what would have been a
reasonable policy on its own and saw
the start of a price war. That instilled
fears of a prolonged problem.
There’s plenty to fear in the world.
Shifting oil prices shouldn’t be on the
top of most investors’ lists.B
Ellen R. Wald, Ph.D. is president of Trans-
versal Consulting and a nonresident senior
fellow at the Atlantic Council. She is the
author ofSaudi, Inc.: The Arabian King-
dom’s Pursuit of Profit and Power.
By Ellen R. Wald
“Low oil
prices over
the next few
months will
function
essentially
as a
stimulus
package for
a struggling
Chinese
economy.”
Dalbert Vilarino Ellen R. Wald