Thought March 09, 2020 / 09:38 am UTC

Oil Plunges, but OPEC+ Deal Likely by the Summer

By Mike Gallagher

The price war between Saudi Arabia and Russia will likely last a couple of months before there is a deal on new OPEC+ production cuts. WTI oil prices will recover, but only to $45 by end-2020. 

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.

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I, Mike Gallagher, the lead analyst certify that the views expressed herein are mine and are clear, fair and not misleading at the time of publication. They have not been influenced by any relationship, either a personal relationship of mine or a relationship of the firm, to any entity described or referred to herein nor to any client of Continuum Economics nor has any inducement been received in relation to those views. I further certify that in the preparation and publication of this report I have at all times followed all relevant Continuum Economics compliance protocols including those reasonably seeking to prevent the receipt or misuse of material non-public information.