A closer look at oil prices and OPEC, Saudi Arabia
It goes without saying that oil prices largely depend on global output which is regulated through quotas imposed by OPEC on major oil exporters. Nevertheless, quotas and agreements of the cartel are not the only driving forces in the oil market that has become the political theatre with the key actors: the US, China, Russia, and OPEC. So, global investors are watching the breathtaking performance directed by Saudi Arabia.
Production cuts keep global market balanced
It is common knowledge that the only way of fine-tuning oil prices is coordinated production cuts. In response to declining demand, the cartel agrees on output cuts. At the same time, oil exporters step up production rates when global demand is on the rise. However, not all oil exporting countries are committed to such agreements. Actually, the share of oil from the defiant countries in the total output accounts for 10-15% that saves the global oil market from a glut. Non-OPEC Russia and Norway still participate in the pact.
Despite the seeming unity and common interests of OPEC and its allies, both the participants in the pact and the violators enter into agreements with an eye on their own goals. In practice, all of them seek to outpace rivals and earn at most. As a result of such ambitions, Russia and Nigeria breached their commitments in terms of output and exports in April and May. OPEC did not neglect such violations. In July, the cartel decided to scale back historic output cuts starting from August. At the same time, amid the cautious revival of the production, Nigeria, Russia, and other defiant countries are not permitted to ease quotas. Experts say that Russia and Nigeria ventured to boost output in the wrong time as global oil prices slumped in April - May to the weakest level over 13 years. Remarkably, crude prices briefly traded even below zero but it will be discussed a bit later.
When it comes to pricing trends in the oil market, it is important to pinpoint the market leaders and the most comfortable export prices for them. For Russia, the lowest threshold which makes oil exports gainful is $25 - 30 a barrel. However, this is the price which generates modest revenue and enables an oil company to make up for production costs but does not allow investment in new oil projects. To encourage development of the oil sector and ensure steady revenue to the public purse, the price should be higher at $35 - 40 a barrel.
The situation is even more complicated for the US. Its shale companies battled successfully with other oil suppliers 5-6 years ago. Nevertheless, US shale firms make profits at $40 - 45 a barrel that is certainly above the production cost. If the oil price falls below the drilling cost, US shale producers do not launch new drilling rigs leaving 50% of available rigs idle. The thing is that the US is not able to impact directly on the oil market when the global oil price slips below $40.
Amid the uptrend of oil prices, Texas, the cluster of shale facilities, virtually floods the global market with oil, so the oversupply pushes oil prices below $40 and American shale companies again have to curb their output. In other words, despite the rapid technological advance that drives costs down, the US is certainly less influential than the kingpin of the oil market, Saudi Arabia. Oil traders joke that Riyadh can pump oil just thrusting sand anywhere in the vast desert with a finger. In fact, oilfields are very shallow in the Kingdom of the Two Holy Mosques. Saudi Aramco makes a profit invoicing its crude at $15 - 20 a barrel. Besides, the Kingdom has another amazing tool. Unlike other export-reliant economies, it can keep afloat when oil prices tumble below $10 and even at negative market quotes. How come? The truth is that the oil industry makes up over 50% of its GDP. In terms of foreign trade, oil exports account for 90% of its trade balance. Thus, Riyadh has amassed humongous reserve funds, so that it can woo its customers by low invoices for months and perhaps for years. The beauty is that the Saudi authorities do not have to launch large-scale social programs like those in the US or Russia.
For traders
speculating in currency pairs, commodities, and bonds, it would be a good idea
to be aware of those price corridors for major oil exporters. This information
helps to foresee and recognize a trend for a currency, commodity, and equities
in a particular country. Importantly, bond traders should grasp the point that
cheap oil drags down not only stocks of oil drilling and servicing companies
but other oil-related firms.
Quotes can turn negative
Market oil
quotes are seen as the most accurate barometer of global economic conditions.
If the world's economy is booming, oil is trading in the uptrend. On the
contrary, an economic crisis pushes oil prices down. In April 2020, the price
of US oil turned negative for the first time in history. It means that shale
producers were paying buyers to take the commodity out of their storage
facilities. The question is why they did not just pile up their stocks or did
not turn their drilling rigs to the sleeping mode. First, their storage
capacity could run out in May. Indeed, nobody predicted that the coronavirus
would cripple manufacturing activity worldwide that would slash global energy
demand. Mass media posted photos of thousands of tankers jammed along the US
shores because oil companies had to rent tankers to store exorbitant oil as
inland storage facilities had been stuffed in full. Second, the principle of
oil drilling is a nonstop production cycle. Once an oil rig was launched, it is
impossible to cut a stream which flows under pressure. Technically, an oil flow
could be made thinner by tightening a valve but it cannot be shut off
completely. If hydrostatic pressure gets too strong, this will destroy the oil
well. Back to trends in the oil market, prices respond to any change. The
global economy was reopened in early May and oil prices recovered to the level
of $40+ a barrel that is comfortable for almost all market participants.
US - China jitters affect oil
Apart from the coronavirus, the jitters between the US and China also play havoc with the global economy and the oil market. The two top economies have been engaged in the lingering trade war. No wonder, oil quotes are highly sensitive to oil production rates and energy demand of the two largest oil consumers. If Washington or Beijing slaps new tariffs on each other's imports, oil prices instantly go down. In contrast, a thaw in the relations is mirrored in growing oil prices. Those who trade oil-related assets are recommended to keep close tabs on two factors in six months ahead. Make sure you monitor developments in the US - China trade war as well as reckon the risks of the second pandemic wave worldwide this autumn - winter.
This article was submitted by InstaForex group.
