A man has had to be rescued by helicopter from the Pyrenees mountains after trying to walk from France to Spain to buy cheap cigarettes. Having initially tried to make the journey by car only to be turned back at a checkpoint, the man decided to attempt the journey by foot. After falling into a stream, brambles, then getting lost, the man was found “exhausted, shivering, cold and lost”. He was fined 135 euros for breaking Covid-19 lockdown rules, and in the end failed to buy cheap cigarettes.
After weeks of heightened volatility, market participants are no doubt also feeling exhausted, shivering and lost. Asset class returns in sterling and local currency are below; following a painful fall, the winner of the week was the oil price as rumours circulated that Russia and Saudi Arabia had been talking about a potential supply cut.
Table 1: GBP total returns
Table 2: Local CCY total returns
You may recall a few weeks ago  that we mentioned in passing that the week was bookended by two major events; the US Federal Reserve cutting interest rates by 100bps (1.00%), and an emerging oil price war between Russia and Saudi Arabia. With the remarkable move last week, we will now touch on the latter but before we dive into what has driven recent price action, it’s useful to set the backdrop for the oil & gas industry today.
A dramatic surge in production from shale oilfields in the US since 2014 combined with an end of a US crude oil export ban in 2015 has seen the world’s largest economy reverse its status as a net importer to becoming the world’s largest oil producer and a net exporter. The magnitude of this rise has had a dramatic impact on the global energy markets, most notably seeing the collapse in the oil price where barrel prices fell from $144 in 2014 to $27 in 2016. Until this point, oil markets had been overwhelmingly dominated by two oil rich producers; Russia and the Organisation of the Petroleum Exporting Countries (OPEC). In late 2016, Russia and OPEC and other non-OPEC members created an informal alliance (dubbed OPEC+) where they agreed to cooperate by cutting production in order to manage the price of oil in order to keep government revenues steady.
Following the coronavirus outbreak in Wuhan, the unprecedented shutdown of the Chinese economy led to a fall in oil demand, triggering an emergency OPEC summit. OPEC agreed on further production cuts and called on Russia and other non-OPEC members of OPEC+ to follow suit. However, Russia rejected this demand, thus marking the end of the informal alliance and resulting in a drop off in the oil price. The impact on energy markets was compounded when just days later, Saudi Arabia announced that it would ramp up its production by over 20%!
The next logical step would be to talk about Saudi Arabia’s or Russia’s intentions, but this is currently still a mystery as both Russian and Saudi officials deny the existence of a price war against each other. Nevertheless, this hasn’t stopped speculation amongst market participants that it might not be a coincidence that the Trump administration placed sanctions on Russia’s largest oil company Rosneft in February, and the largest victim of the oil price war started by Russia in March is the US shale industry. The reason US shale producers suffer on average more than anyone else is that analysts estimate they require around $40/barrel or above for extraction to remain profitable. It’s thought that with prices at $35/barrel, just 16 US producers can operate economically. Thus, with the price under $30/barrel, there will undoubtedly be some damage done to the industry.
Until social distancing measures are relaxed across the world and oil demand begins to recovery, or Russia and OPEC come to an agreement to cut supply, it’s difficult imagine a scenario that could result in oil moving significantly from its current levels. As such, while a 30% move in the oil price in the asset return tables above might look significant, it must be remembered that the commodity is currently at a very low base and is extremely sensitive to any news flow concerning Russian-Saudi Arabian relations.
As usual, we have updated the chart showing confirmed coronavirus cases below.
Source: John Hopkins University
STAT OF THE WEEK: £19 billion – the value of UK food waste per year (WRAP).