July 2020 – @alvaroriosroca – Those of us who believe that the market should set the prices of products and services can once again tear our hair out over recent events in the global oil market.
What we will explain is precisely the interference with a critical look at something that we will continue to preach. It is much more beneficial that the market (supply and demand with all its distortions) in competition, set the prices of products and services, to do so by hand, politicians of the moment. Most of the time in concomitance with those who favour fixed prices or taxes.
It is one thing to regulate costs in order to establish prices or tariffs for public services where there are natural monopolies and no competition. Also de facto monopolies of market dominance by one, two, or more agents must be broken to generate competition. That is the task of governments. Price agreements between market agents is a violation of the market that must be punished and censored. Exactly the latter is what happened with the famous OPEC+ and of course with the interference of President Tump. Let us analyse.
During 2018 to 2019 oil prices were set between 60 to 70 USD/Bbl giving peace of mind and of course profits to producing countries and companies producing the vital element that still drives the world economy and transport.
Global production during those two years averaged 100 Million Barrels per Day (MMBPD). However, at the end of 2019, the eruption of COVID 19 in China occurs and the alert begins to affect demand. Oil production however remains at 100 MMBPD, but prices begin to decline. WTI and Brent prices in January were already 57.6 and 63.6 USD/Bbl and in February they fall to 50.6 and 55.7 USD/Bbl respectively.
With this scenario, on March 5 there is a two-day meeting of OPEC and its allies, called OPEC+, including Russia with the aim of trying to establish production reduction quotas and raise prices. On March 6th the barrel of oil fell another 10% after talks failed and where Russia refuses to reduce production.
On March 9 Saudi Arabia unleashed a price war on Russia for its refusal to reduce production and of course prices plummeted to an average of 30.5 USD for WTI and 31.8 USD for Brent in March. At the end of March prices were already below 25 USD/Bbl at 2002 levels. Guess what? In this scenario of prices below 30.0 USD/Bbl, none of the shale frackers in the USA could continue to fracture the rock, because it was uneconomic (break-even point) and there was no way to pay debts in a sector that was also highly indebted.
This is how some tweets from President Trump appeared on April 2nd, which made prices rise almost 25%. In them he announces that there was hope for an agreement between Moscow and Riyadh to cut production. On April 3 prices gain another 10%, driven by optimism about the end of the price war between Russia/OPEC+. With stick and carrot in hand the powerful US president begins his action.
On April 9, after an OPEC+ meeting via videoconference, a historic agreement is reached to reduce production by 10 MMBPD, which of course is not enough due to the oversupply and the super demand contracted by the virus. On April 20, an unprecedented day for the oil market, prices fall to negative 35 USD/Bbl for May futures due to lack of storage. The demand in April falls to 79 MMBPD that is a global fall of 21%.
Well, thanks to cuts by OPEC+ countries and pressure from the USA and its partners, prices have begun to climb, reaching 40.0 USD/Bbl this June. The interesting thing about this is that it is the first time in many decades that we see the American government eager to raise oil prices because the opposite has always happened.
Well now there is a thriving shale industry involved that needs to be protected. The oil production of the frackers in the US had reached 13 MMBPD and now it has started to decline because of the companies’ actions at 11 MMBPD. We have already said that not even the most efficient frackers in the neatest sweetpots are profitable below 30 USD/Bbl.
Well, as in the USA, the government cannot impose a reduction in production on the oil companies (we believe that this could be considered illegal), since the carrot and stick worked with OPEC+. How times and interests have changed. The low prices of fuels that benefited its citizens when imports were Dantesque are no longer the main thing for the US government.