In March 2020, with the price of Brent crude oil reaching historic lows around $30 per gallon, the Ministry of Oil Production in Iraq sounded the alarm and requested an emergency hearing with the Organization of Petroleum Exporting Countries. Minister Thamer al-Ghadhbahn stressed the extremely risky economic conditions that his country was facing. Iraq is heavily dependent on revenues from oil production, and the prospect of having to endure a $30 price range even for a couple of months was downright scary for a country of 38 million residents.


On the day following Minister al-Ghadhbahn’s urgent request for an OPEC meeting, trading was halted at the New York Stock Exchange after the S&P 500 benchmark index tumbled by 7%. This was the fourth such intervention on Wall Street since the World Health Organization declared the COVID-19 outbreak a pandemic, but market analysts noticed another worrisome trend. While crude oil is not exactly a “flight-to-safety” commodity, investors are known to take temporary refuge in oil futures contracts, but the action at the Chicago Mercantile Exchange was underwhelming in this regard. Traders seemed to be staying away from oil futures, and most of the contracts written were for short positions.


The one-two punch delivered to oil prices in March had a lot to do with the coronavirus pandemic. With major economies on lockdown, global industrial output was sharply reduced, thus lowering demand for oil derivatives. Passenger flights were grounded and cruise ships docked; even ground transportation services were curtailed, but there were other factors keeping oil prices down.


The Kingdom of Saudi Arabia and Its Painful Strategy


Not long before the slump in demand for crude oil and its derivatives, OPEC representatives of Saudi Arabia had a strategic difference of opinion with Russia. Over the last few years, OPEC has tried to do something about the downward spiral of crude oil prices, and the members of this bloc agreed on a strategy to manipulate production. This Keynesian move was initially effective to a certain extent; however, problems started when production of shale oil reached boom status in the United States. To make matters worse for OPEC, global interest in renewable energy drove production costs down, thus making solar and wind power projects very attractive.


By late 2019, Russia had grown unconvinced about the impact of production cuts. After a few OPEC meetings in 2020, some of them conducted while the Chinese city of Wuhan was struggling to deal with the coronavirus outbreak, Russia decided to stop participating in the production manipulation strategy. With Russia extracting, refining, and shipping more oil, the Kingdom of Saudi Arabia decided to compete accordingly, thus sending petroleum prices in a tailspin dive. Now we have two OPEC giants producing more oil than the world is willing to utilize because the pandemic has brought things to a standstill.


As Middle East expert Amir Handjani has previously written about, the Kingdom wants to assert its global oil production leadership with strategies that go beyond direct manipulation. While Saudi officials would like to see a return to $100 oil barrels, they know this is unlikely to happen, but they still need to come close to $80 per barrel in order to meet budgetary goals. Realistically speaking, a return to $50 per barel would be welcome in 2020; does this sound feasible in the age of COVID-19?


Raw Production Versus Strategic Investment


While it is true that the Kingdom still counts on petroleum as a major driver of its economy, this OPEC giant is not in such dire straits as Iraq. Saudi Aramco, the national business entity in charge of energy production, has been making interesting investment moves in recent years. Mr. Handjani has commented about the interest that Aramco has acquired in the operations of Reliance Oil, India’s most prominent energy provider. The stake held by Aramco in Reliance is significant, and it has some built-in diplomatic aspects.


Aside from its Reliance Oil investment, Aramco has also been taking positions in other fuel production operations in other parts of the world, even in the United States. While the Reliance deal is closely tied to oil extracted from the Kingdom’s vast reservoirs, many of the other Aramco investments are not. In fact, a new $500 million fund launched by Aramco in early 2020 has nothing to do with crude oil; the Saudi Aramco Energy Ventures investment company is more interested in renewable energy projects. The managers of this fund are particularly interested in hybrid projects such as water treatment plants powered by both gas and solar energy.


Getting back to the issue of whether an oil price recovery can be expected in 2020, it can be safely assumed that Saudi officials are really hoping for this to happen, but they also seem to be preparing for a worst-case scenario of oil prices getting stuck around the $50 level for a while. What we should expect is plenty of volatility; investors are going to be treating the commodities market like a day trading playground as long as news about the pandemic dominates global headlines. Short sellers usually thrive on times of uncertainty, and this is the case for other commodities.


History shows that oil gluts only last a few months. The situation between Russia and Saudi Arabia will be straightened out in the future; let us not forget that there is a bit of ruffled-feather diplomacy at play with regard to Russian involvement in the Syrian War. Once the world finds stability in relation to the COVID-19 pandemic, demand for crude oil will increase and prices will rise accordingly, but $80 barrels may not be attainable anytime soon. The Kingdom will continue to explore strategic investments that may not be directly tied to oil production.


The best-case scenario for the Kingdom is not so much going back to the halcyon days of $100 per barrel; instead, not having to worry as much about market gyrations would be the most ideal situation. To this effect, we will likely see Aramco diversifying its asset portfolio in a way that no longer puts crude oil front and center.


Categories: Business