Saudi Arabia's decision to provide large discounts to European customers shows that it is going for market share in a price war with Russia after OPEC failed to agree to new cuts in production. Though Saudi Arabia has used this policy before in 2015, it now appears to be directing efforts toward Russia. Even so, Saudi Arabia and Russia know that this will severely squeeze U.S. shale, and production will probably fall like in 2015 and 2016. The financial squeeze on U.S. shale will become evident starting Monday through much wider high-yield bond spreads.
The difference from 2015 is that the COVID-19 crisis is curtailing oil demand, which threatens to prolong super-low oil prices unless there is a production cut. Additionally, while Russia can weather short-term pain, it will want to see oil prices back above $45 to ensure long-term fiscal stability.
Our new central view is that an OPEC+ production cut will be evident by early summer, which can lift oil prices from depressed levels. However, the price war will impact internal OPEC cooperation, while Saudi/Russia cooperation will take time to rebuild. This means that the cumulative scale of production cuts is unlikely to match the previous and proposed total cuts. In turn, production cuts probably will not be sufficient to remove excess inventories from the market, which will cap the rebound in oil prices. We now see WTI at $45 by the end of the year, which is also based on our central scenario that COVID-19 will be contained.