SINGAPORE (Mar 9): Oil prices suffered the greatest price collapse since 1991 after Saudi Arabia ignited a price war with Russia following the latter’s refusal to join production cuts with OPEC. 

Shortly after the opening bell, the international benchmark Brent crude, plunged from US$45 a barrel to US$31.52 in the span of a few seconds, denoting one of the biggest intraday falls in its history. 

OPEC had convened in February in an emergency meeting to discuss further production cuts in light of the coronavirus outbreak, which was then largely confined to China. A proposed 600,000 barrel per day cut fell through when Russia opted against that decision.

Saudi Arabia then announced unprecedented discounts of close to 20% in key markets, largely targeting the Russian and American shale industries, as well as other higher cost producers. 

“Saudi Arabia is set to announce that its crude into northwest Europe, a key market for Russian barrels, will be sold at discounts to its reference price of over US$8/barrel compared to that of March 2020,” says AmBank analyst Alex Goh. 

“Saudi Arabia also made price cuts of US$4–6/barrel to Asia. This aggressive price war is evident as monthly Saudi price adjustments are usually only by a few cents to US$1,” he adds. 

According to OCBC Treasury Research, although Russia has a higher marginal cost of oil production than Saudi Arabia, it has budgeted a fiscal breakeven of US$42 per barrel – almost half that of Saudi Arabia’s US$83 per barrel.

“This has allowed Russia to beat Saudi Arabia at its own game, despite being strong-armed by OPEC to cut production leading up to last Friday’s OPEC+ meeting,” says OCBC economist Howie Lee. 

The way Lee sees it, this has well been part of Russia’s game plan all along, as the country has been actively diversifying its economy following the collapse in prices during the 2014-2015 shale boom, in which its economy took a battering. 

“Russia has been consistently budgeting a lower fiscal breakeven oil price while diversifying its economy to other sources of non-oil revenue,” notes Lee. 

See: Global markets tumble as power hungry Saudi prince wages oil price war

Prepare for lower prices

But around the globe, market watchers are bracing themselves for the worst. Goldman Sachs, for one, has issued a “dire” warning which could well be what investors have feared for a long time: a price tag of US$20 per barrel of oil. 

“The prognosis for the oil market is even more dire than in November 2014, when such a price war last started, as it comes to a head with the significant collapse in oil demand due to the coronavirus,” writes Goldman Sachs oil strategist Damien Courvalin in a note to clients. 

“As a result, we are cutting our 2QFY2020 and 3QFY2020 Brent price forecasts to US$30/barrel with possible dips in prices to operational stress levels and well-head cash costs near US$20/barrel,” adds Courvalin. 

A ripple effect

With the S&P e-mini futures falling by 3.5% in the first hour of trading, OANDA Asia-Pacific senior market analyst Jeffrey Halley envisions that this marks a grim start for Asian equities. Asia alone hosts three “huge” net oil importers. “That will likely be only a cold comfort; with both Japan and South Korea in particular, having limited room to manoeuvre on the monetary policy front.” says Halley. 

As regional oil producers, Indonesia and Malaysia are likely to be in the firing line, with Singapore’s “huge” petrochemical industry taking a hit as well. Australia, too, is also expected to feel the brunt as natural gas prices sink in tandem with oil prices. 

On the flipside, India is likely to be the only winner for the day. As a huge net energy importer grappling with a myriad of problems such as current account issues, stagflation pressures and a banking crisis, the oil price collapse is what Halley terms a “welcome shot in the arm” for the Reserve Bank of India. 

Apart from equities, OCBC’s Lee says that impacts on almost all goods and services industries are inevitable. 

“Oil prices play a crucial role in direct inflation inputs and have secondary effects in the costs of productions in almost all goods and services,” says Lee, adding that lower oil prices are almost certain to trigger deflation in developed countries and the global economy at large. 

“This will have an impact on monetary policy, as policy makers see the space and impetus to further loosen monetary policy as they try to keep prices from spiralling into an uncontrollable deflationary cycle,” he adds. 

Mizuho Bank's head of economics and strategy for the Asia and Oceania treasury Vishnu Varathan says that Asia could be impacted severely, given its exposure to both the oil industry as well as the rapid worsening of the Covid-19 outbreak.

“We expect that the oil-Covid driven risks deepen a sell-off in markets and could weigh on EM Asia FX,” says Varathan. 

“[A] further fall in Oil could revive memories of 2014-15 tempting speculation of the Monetary Authority of Singapore’s inter-meeting easing. In any case, best to buckle up and brace,” he adds. 

Excess capacity, weak demand

AmBank’s Goh says that should Saudi Arabia restore its capacity of 12 million barrels per day, one can easily expect oil prices to crash below US$30.  

The bank has lowered its oil price forecast to US$40-45 per barrel for 2020, and US$60-65 per barrel in 2021. These are in line with the rising excess oil capacity that is likely to flood global markets, as well as the weak demand on the back of the Covid-19 outbreak. 

OANDA’s Halley opines that oil prices are unlikely to recover anytime soon, and the market at large is set for a “nightmarish year” ahead.    

“Oil prices, therefore, will likely be capped over the next few months as coronavirus stalls economic growth, and Saudi Arabia opens the pumps and offers huge discounts on its crude grades,” shares Halley. 

“Production [is] becoming a battle of who has the deepest pockets,” he notes.”For today, however, we may have seen the worst of the oil sell-off in the near-term.”

“That said, any rallies from here are likely to be met with walls of sellers, and it is hard to envision Brent crude back above US$40 a barrel in the next few months,” adds Halley. 

Local stocks hit

The Singapore stock market was not spared by the global panic. The benchmark Straits Times Index fell 3.1% on the opening bell to a new 52-week low, shedding 91.48 points to 2,869.50 as at 9.04am. 

Some 139.1 million securities worth $187.4 million changed hands, with commodities counters being among the most heavily traded. 

As at 11.20am, Conglomerate Keppel Corp had fallen 6.11% to $5.84, while Sembcorp Industries fell 7.35% to $1.64. Rig builder Sembcorp Marine tumbled 9.41% to 91.5 cents. 

Apart from industry moguls, smaller companies felt the pinch too. Rex International emerged the most heavily-traded counter with some 77.8 million shares changing hands. Its share price plunged 26% to 13.1 cents. 

Interra Resources, AusGroup, Nam Cheong and MarcoPolo Marine saw their prices sink by 24.2%, 22.2%, 14.3% and 11.1% respectively. 

The oil and gas sector is in for a rough year ahead. “Oil exploration projects will go belly-up as it becomes unprofitable to conduct oil exploration at such depressed prices,” says OCBC’s Lee.

“Many O&G companies are expected to go into bankruptcy or receivership and defaults on loans are expected, not unlike what was observed in 2015,” he adds.