The interrupted OPEC+ deal and the rapid decline in world demand due to Covid-19 have sparked some real excitement in the world oil market, as new negotiations between the ministers of oil-producing countries have started. The excitement is such that there seems to be no room left in everyone’s attention to recall what really is the significance of this energy resource for the entire world’s economy and what could be the consequences of a long, steady decline in world oil prices.
The fact that crude oil trading is of global importance even without petroleum products is actually very easy to verify and does not require any professional knowledge of the rules of exchange trading. It is enough to take into account only two well-known facts: the first one is that the share of physical oil trade on world commodity exchanges, even according to the most optimistic estimates, is 20 times less than the trade in futures and other oil derivatives, such as “paper” ones. The second fact is that by the end of 2019, the volume of world oil production and consumption had reached a round figure of 100 million barrels per day. The calculator will tell everything else: the annual volume of oil production and sales is around 36 billion barrels. According to the International Energy Agency (IEA), the average price for a barrel of Brent crude oil was $59, which means that the annual turnover of physical oil trade was approximately $1.8 trillion, and the annual turnover of “paper” oil trade was about $ 36 trillion. This is without taking into account the hedging market for transactions, and without taking into account the trade in petroleum products. Given these operations, the numbers are to be truly astronomical.
The economic and physical characteristics of oil
Surprisingly, we do not often think of the volume of world oil trade. The focus rather goes on the volume of daily production, daily trading operations, the distribution of market shares among major players, and so on. The coin, as it often happens, has two sides: on one hand, there is nothing good about the fact that the ginormous financial resources that could be invested in development projects in most economic sectors of various countries in the world are instead exclusively used for speculative operations. On the other hand, the market, the spontaneous nature of the world’s economy when investing such volumes in the real sector, would inevitably lead to a complete imbalance of the economic system of the planet. The largest commodity exchanges, the New York NYMEX, the London ICE, the Chicago CME Group, the Singapore CGX and the Dubai DME are not only trading floors, but also quite peculiar “accumulators” that can be used for speculative money—that very money that American and European banks provide at minimum interest rates. As a result, the inflationary pressure of this money s minimized, and this is sometimes presented to us as one of the western economy’s incredibly effective ways.
The second characteristic of oil is that it is a finite product, thus its resources and reserves on the planet will eventually end sooner or later. It is also important to keep in mind that oil products do not only consist of gasoline, kerosene, diesel fuel, oil fuel and tar. In fact, the range of oil products is a very extensive one: they are used for the production of tire products, in the rubber and cable industries, in the textile, metallurgical, woodworking industries, plastics, lubricants, varnishes, paints, pulp and paper products are all made from oil, and the list goes on and on. The lack of oil supply will inevitably lead to problems in all these sectors, to an increase in production costs and to a loss of balance in the world trade system.
The debate of whether or not the peak of oil has passed has been going on for decades. There have been innumerable predictions that “another 15-20 years and there will be no oil left on the planet”, and only the lazy ones did not make fun of the optimists who did not agree with this claim. But oil still wasn’t ending, and so was the worldwide demand and supply for it. With every passing year, new, more efficient technologies for prospecting, exploration and production are being developed and implemented. There are more new fields being discovered, technologies that make it possible to develop fields offshore and on the seabed with economic feasibility are emerging, and the latest innovations can increase the oil recovery factor from old fields.
The most widely known example of a new oil production technology is the so-called shale production, that is, oil production using hydraulic fracturing technology. This method was first proposed by Soviet oil industry workers at the turn of the 60s, but it did not gain popularity back then, since new oil fields in Western Siberia made it possible to produce oil by traditional, much cheaper methods. The term “shale oil” is quite common, but its decryption isn’t. So let us briefly recall what, in fact, it actually is.
The oil contained in the “underground storage rooms” is far from being some kind of “underground lakes” in which you have to “stick a pipe and turn on the pump”. The reality is completely different. Oil is contained in oil-containing formations, that is, voids between accumulations of solid particles. The ability of rocks to contain oil is called total porosity. However, the fact that the reservoir in their pores contains oil does not make the oilmen’s job easier, since they can’t just extract it from each pore separately. It is important that there are such pores along which oil could move when a change in pressure occurs. A formation located at great depths experiences the pressure of the entire mass of rock above it. The producing well can be seen as a broken cork from a bottle of champagne. The task of oil producers can be successfully solved only if there is a sufficient number of pores in the oil reservoir along which the oil can move in the direction where the low pressure has formed (towards the well, that is). The presence of such pores is thus an essential characteristic of the reservoir.
When it comes to pores, another characteristic is to be introduced: effective porosity. The field of such pores is called the permeability of the formation, and both parameters are important for production (both the presence of oil in the pores of the formation and its highest permeability). Oil shales are low-permeable oil reservoirs: there is oil in the pores, but it cannot move through them because the density of the rock is too high. Most often this happens in formations formed by limestones and dense sandstones: there is oil in them, but it doesn’t move since there is no connection between the oil containing pores. Practice has shown that shale formations also have a small layer of thickness, some kind of thin «pancake» bounded at the top and bottom by layers of rock that oil cannot go through at all. In such cases, a vertical well is of no use at all, and oilmen were forced to develop a technology for horizontal drilling : first we travel vertically to the desired depth, and then we drill horizontally. As a result, a low pressure area appears in the oil shale layer, but the oil is still not able to move towards it since the rock density is very high. What’s left to do is to take the decisive step: find a way to increase permeability. In order to do so, hydraulic fluid is fed into the reservoir under high pressure, which “breaks” the reservoir, and vertical cracks are formed in it.
However, the pressure of the overlying rock layers does not disappear somewhere; over time, these cracks will be “crushed”. Here, in order for the newly formed cracks to exist as long as possible, various chemicals (the so-called proppants) are added to the fluid. The chemicals contained in the hydraulic fluid have the ability to migrate through the created cracks into groundwater. This, in fact, is a brief summary of the reasons why the pipes in the homes of American farmers contain everything but drinking water (lots of videos have documented this). But this is the Americans’ problem with both the inhabitants of the regions in which the production of shale oil has unfolded, and with the environmentalists who have lost consciousness from such a wonderful technology.
We shall note that the founder of the “shale revolution” in the United States, George Mitchell, who brought the technology to a commercial level, took ten years of hard work on the Barnet shale formation in Texas and more than six million dollars until he found the right method of drilling and the composition of hydraulic fluid. His biography is the American “classic” of our time. Industry professionals have teased Mitchell Energy & Development for years, and in 2001, at the age of 82, he sold it to Devon Energy for $ 3.5 billion. This pioneer of American shale mining died in 2013, leaving half of his fortune to charity, but that’s another story.
In search of a price balance
We cited this example in order to show that the development of innovative methods of oil production requires years of work and stable investment. Innovative developments in the oil industry, just like in any other, do not 100% guarantee that they will succeed, and it is thus always a risky investment for which credit financing is impossible. In one hundred cases out of a hundred, financing for the development of new technologies is carried out at the expense of profits obtained through the use of traditional technologies.
It’s quite a simple idea: the company has profits from exploration and oil production, there will be investments in geological exploration and the development of new technologies, but there is no trial. This is what the world witnessed in 2015 and 2016: after a sharp drop in prices, investment in geological exploration decreased from $ 110 billion in 2014 to $ 50 billion in 2016. The result did not take long to show itself: in 2014, deposits were discovered with total reserves of 15 billion barrels, whereas in 2016 there were only 6.9 billion barrels of new reserves. According to the Oil & Gas Journal, the provision of production reserves in 2014 was 60.2 years, and by 2016, 57.9 years. It’s not the most significant decline, but it clearly shows what awaits us if the current dramatic price reduction turns out to be “long-playing”. After a few years, it will “suddenly” become clear that there are no new discoveries and the old deposits have reached their final stage. And then there will be a search for investment sources in emergency mode, bank loans will go into action, prices on stock exchanges will rise by tens of percent every month. This is something that should always be kept in mind: the countries participating in the OPEC + agreement fought not only for short-term profits, but also for the world not to encounter a multiple increase in the price of “black gold” at one same, completely awkward moment.
The higher the price, the calmer and more confidently will oil companies invest in exploration and development of new technologies. But this coin also has two sides: with rising prices, it is important not to overdo it, because after a certain threshold value demand may fall, and the high price of raw materials for the oil refining and petrochemical industries can lead to the winding up of one or the other or to attempts to mass transfer alternative energy sources. 2012-2013 was not only the time when the price of a barrel ranged about 100 dollars, but also the time when EU countries began to actively invest in the development of “green energy”. The current low prices will last for a long time, and the European Commission will “suddenly” remember that the sun and wind are not able to provide stable electricity production, that industrial energy storage devices have not yet been developed, and that the burning of natural gas doesn’t actually produce much carbon dioxide, hence its contribution to global warming not being so great.
The 2016 OPEC+ agreement
The task that the OPEC + participants tried to solve was the search and struggle for balancing the price of oil, which should give the opportunity to invest in technology and exploration, and not force consumers to look for an alternative to hydrocarbons. This problem was to be solved by countries of completely different economic and technological systems, yet they did manage to find a common ground and smooth over the existing contradictions. We shall recall that OPEC includes 13 states, while 10 countries (in addition to Russia) have joined the “plus sign”. Hence, 24 countries have managed to conclude a mutually beneficial agreement—it is unlikely that our current tough times you can find at least one more such large-scale international project. Now it is not very often remembered how difficult it was to prepare for the meeting of OPEC+ energy ministers in Vienna (which is where the headquarters of the oil cartel are located) on December 10th, 2016, during which all participants signed the terms of the agreement on the total reduction of oil volumes.
There were preliminary meetings and numerous negotiations between the Minister of Energy of Russia Alexander Novak and the leaders of Saudi Aramco and the Ministry of Energy of the Kingdom, and these were covered in the media to some extent. Also, on the sidelines of the 11th G20 countries summit held in 2016 in China, Vladimir Putin had a brief meeting with Mohammad Bin Salman, who then held the title of “successor to the Crown Prince of KSA”. Perhaps the only comment on this issue was made by the press secretary of the President of Russia Dmitry Peskov:
“Cooperation in the field of oil was also mentioned, but the focus was rather on areas related to finance and high technology.”
Of course, the information is absolutely accurate: this meeting had nothing to do with the OPEC+ agreement that was to be signed in three months. Absolutely no correlation whatsoever.
OPEC + actions and global statistics
The terms of the agreement signed in December 2016 (the cumulative reduction in production by all participants of 1.8 million barrels per day) became the basis for the fact that in January 2017 the price of oil rose sharply. The participants in the OPEC+ announcement were quite pleased with themselves, since they had the opportunity to resolve issues with their state budgets, to start increasing their foreign exchange resources, and oil companies once again began to build investment plans for exploration and technology development.
But here is a small assortment of statistics for the end of 2017: the world oil production in 2016 amounted to 3907 million tons, whereas the results of 2017 are 3903 million tons, which means that the actual decrease was only 0.1%. What had «died» through the efforts of OPEC +, «arrived» through the efforts of those who were absent from the meeting in Vienna. In 2017, Saudi Arabia reduced its production by 2.7%, and Russia by 0.2%. Venezuela demonstrated a sharp decline by 10.3%, production in Mexico decreased by 7%, and the total production volume decreased only by a tiny 4 million tons (29 million barrels). When it comes to percentages of production growth, Canada has shown to be the most distinguished: a «plus» of 5.7%, but the volume of production in absolute terms in this country is not so significant as to make an actual change to the global statistics. However, a 4.2% growth of oil production in the States, that’s a serious deal: it was the production of shale oil in the USA that leveled all efforts of OPEC+.
In December 2017, shortly after the first ever visit of the King of Saudi Arabia in Russia, the OPEC+ countries extended the agreement for the coming year 2018. But this limitation of production did not prevent Russia from improving its position in the global oil market: on January 1st, 2018, the first stage of the ESPO (Eastern Siberia — Pacific Ocean) trunk pipeline was completed, which allowed a sharp increase in oil supplies to China. But volume was not the only important factor: the ESPO pipeline started transporting ESPO light oil, which allowed to change the export structure: the share of heavy oil began to decline, the share of light oil increased. As a result, the foreign exchange earnings of oil companies and, accordingly, tax revenues to the state budget increased.
We shall recall that Urals is traded at a discount of 10% relative to Brent oil, and ESPO with a ten percent premium on this standard, which means that the difference in export prices between Urals and ESPO is of 20%, with export duties differing by the same amount. But this is not the reason why 2018 results were most interesting: despite the validity of the terms of the OPEC+ agreement, global production did not decrease, but increased by 1.3%. The reason for this was simply an explosive increase in production in the United States, which for 2018 added 16.5%, having come out on top in the world with this indicator, ahead of both Russia and Saudi Arabia. This did not lead to a decrease in world prices, since the United States also ranks first in the world in terms of oil consumption: they reached absolute export with only 1.9 million barrels per day.
Canadian oil companies all acted in unison: heavy oil coming from the oil fields of this country became more demanded by its southern neighbor and main consumer, since according to the results of the year, oil consumption in the USA grew by 2.7% which, taking into account absolute values, was a very significant increase. In short, in 2018, the States began entering foreign oil markets, and this continued in 2019, as we have already discussed in a previous article.
The market is not only made of suppliers, but also buyers
All of the above applies only to the countries that produce oil. But an analysis of the situation going on the world oil market without at least a quick overview of what is happening in terms of world demand will not be a complete one. The year 2017 was also a significant one when it comes to demand: for the first time in history, China came out on top in terms of crude oil imports, ahead of the United States. That same year, Russia became the leader in deliveries made to the Chinese market, overtaking Saudi Arabia in terms of volume. In 2018, China ranked third in the structure of US oil exports, for which Canada was the largest buyer and South Korea—the second largest. In 2018, another potential leader in terms of oil imports was identified: India. That same year, oil consumption growth amounted to 3.5% in China and 4.5% in India. However, the low base effect does not yet allow India to play a significant role in the world market. The year 2019 was a peak in the trade war, the import duty war that erupted between China and the United States ever since the current head of the White House came to power.
China, in response to the sharp increase in duties on its goods introduced by the USA, did not stay quiet: Beijing raised duties on American energy resources, oil and LNG. The volumes of deliveries from the United States to China ever since the second half of 2019 have turned into a statistical error, however, as we have seen, Trump had, well, a trump up his sleeve. The sanctions imposed by the States against Iran, and then against Venezuela, reduced the level of diversification of oil imports for China. The terms of the OPEC + agreement did not allow Russia to enter the Chinese market with Urals oil, as a result of which Saudi Arabia was able to increase supply to China by 150 million barrels and oust Russia from the position of the largest oil supplier to this country. We must emphasize that in this case, we are not talking about Rosneft, but specifically about Russia, since LUKOIL and Gazprom Neft are increasing deliveries to China. It was these three companies that signed an agreement with Transneft and China on the ESPO project, and it is thus these three companies that supply ESPO oil through this pipeline.
The war of trade duties and the maneuvers of its participants
Throughout 2019, there were ongoing negotiations between the authorized delegations of China and the United States : both countries suffered significant losses from the war of duties and were interested in restoring normal trade relations. Here’s another noteworthy nuance: both China and the United States understood and still do understand that a restoration of the bilateral trade balance is possible, first of all, due to an increase in the volume of deliveries of American oil, American natural gas, meat, soy, and other such “high-tech goods” to the Chinese market. It’s not about machines or equipment, but actual agricultural products and raw energy resources. Of course, the leaders of China were well aware that the growth of energy imports from the United States would necessarily become part of the “peace agreement” in the trade war. However, Beijing was not pleased at all with the prospect of increasing dependence on oil supplies from the United States and Saudi Arabia grunting at them. No attempts to achieve the implementation of the “oil imports should not exceed the volume of domestic production” strategy did give any results: currently, China imports about 70% of its oil consumption. The ensuring of energy independence and energy security of China is possible only due to the maximum possible diversification. Other than that, there are no options.
In all open sources, there is no information about whether or not negotiations between China and Russia were conducted, so we can only operate on facts. In November 2019, the ESPO trunk oil pipeline reached a maximum capacity of 80 million tons of ESPO light oil with a 10-year lead, 14 million tons of which are intended for refineries in Khabarovsk and Komsomolsk-on-Amur, and 66 million tons are exported. ESPO has an oil drain under the Amur River to the Mohe oil pumping station in China. ESPO geographically ends in a specialized port of Kozmino. It turned out to be a fairly flexible mechanism: Russian light oil enters China both through a pipeline to Daqing (the length of which in China exceeds a thousand kilometers) and through tanker deliveries to ports on the Chinese coast. But Chinese oil refineries and petrochemical plants, just like any others, require not only light but also heavy oil, which China received including from, for instance, Iran and Venezuela. The chemical composition of Urals is as close as could be to Venezuelan and Iranian heavy oils—this was and still is a technical prerequisite for the appearance of additional volumes of Russian oil on the Chinese market.
In January 2020, agreements were signed, and in February Urals oil was delivered to China in the amount of 1.2 million tons of oil (8.8 million barrels), and this is despite the fact that the New Year holidays in China grew into the COVID-19 epidemic, and then into the emergence of strict quarantine measures that led to a sharp decline in industrial production (-13% in February 2020 in comparison to February 2019) and a corresponding sharp decrease in the consumption of oil and oil products. Urals shipments began despite the fact that on January 15, a peace agreement was signed between China and the United States in the context of their trade war. One of the terms of this agreement is China’s commitment to purchase $52 billion worth of energy resources from the United States over the next two years.
Moreover, in March 2020, unnamed Russian companies signed an agreement with unnamed Chinese companies for the supply of another 1.6 million tons (11.8 million barrels) of Urals oil, deliveries of which are carried out during the month of April. Can this possibly happen without serious agreements between Moscow and Beijing? The question turned out to be rhetorical. However, to date, there is no information that the supply of WTI and Bakken oil to China will begin or even be planned. There is news that there have already been deliveries of liquefied hydrocarbon gases (propane and butane) from the USA to China, and there is also news about LNG supplies, but there has been no information about oil deliveries.
A new, expanded OPEC+ meeting
Such was the situation before the meeting of OPEC+ energy ministers on March 6th, 2020, which ended with the parties not only failing to work out mutually acceptable new conditions for reducing production volumes, but also the collapse of the agreement. This was followed by the demarche of Saudi Arabia, which announced its intention to increase production to 13 million barrels per day and to provide European buyers with a discount of 7-8 dollars per barrel, as well as the inevitable dramatic collapse of world prices. We must recall that the Minister of Energy of Russia arrived in Vienna with a proposal to extend the conditions that were developed and agreed upon at the previous meeting in December 2019, that is, the “minus” 1.7 million barrels per day. Such a decision, according to the Russian leadership, would make it possible to more accurately assess the impact of COVD-19 on global oil demand. But this proposal did not make it, and we can see the result: a month has passed, and two days after writing this article, on April 9th, a videoconference of OPEC+ participants has already been scheduled.
This videoconference is not going to happen so much on the initiative of Saudi Arabia or Russia, (which, apparently, are ready to continue the price war). The initiator is Donald Trump who deigned to spend his valuable time on telephone conversations with both Mohammad Bin Salman and Vladimir Putin, though it is true that Trump immediately tried to prove that he still had some trumps to play: the States do not intend to take part in the videoconference, but, «if the need arises, we will intervene.» There is nothing to be done about it: in November, Mr. Trump has upcoming elections in November, and the country has a very serious situation with COVID-19. Hence, he has to “keep face” in front of voters who may already be well doubting the implementation of the slogan Make America Great Again.
The states were completely unprepared for the outbreak of the coronavirus. Quarantine measures are accompanied by a sharp increase in unemployment: the number of new unemployed is counted in millions. The Energy Information Agency (EIA) and the Information Department of the US Department of Energy already managed to publish a revised forecast for 2019 on March 6th: according to experts of the department, while maintaining the price of a barrel of WTI oil at about $25, the decline in oil production in the country will reach 1.6 million barrels per day by the end of the year without any OPEC+ or OPEC++ agreements.
OPEC+ member countries are not the only ones to take the price drop very seriously: production in Canada and Brazil has already decreased, respectively by 200 thousand barrels per day. The COVID-19 pandemic is exerting increasing pressure on demand. Attempts by Saudi Arabia to oust Russian suppliers from the European market did not show any results: demand for all types of oil products has fallen, European oil refineries are nearly 100% full. The OPEC secretariat invited 36 countries to participate in the videoconference, including the United States, Canada, Norway, Brazil and the UK. Experts predict that COVID-19 will reduce oil demand by 10-15 million barrels per day (10-15%) in the second quarter of 2020. We shall note that this forecast shows how erroneous the ultimatum of Saudi Arabia was (which on March 6th required to reduce production by 1.5 million barrels per day). Russia’s proposal was much more adequate: to extend the December agreement and to keep analyzing the situation around the pandemic. Even now, the level of uncertainty remains extremely high, but it is clear that the implementation of the proposal of Saudi Arabia wouldn’t have any effect on prices.
We can already predict with a significant level of certainty how the videoconference will end: there will be no result. The reason is completely obvious: both Saudi Arabia and Russia insist on mandatory participation in the conference and in the development of the terms of the agreement by the United States while Trump defiantly refuses this. He justifies this quite traditionally: due to the demagogy that the oil market in the United States is purely of a market nature, the state cannot intervene in the actions of private companies. This sounds ridiculous, as it is said by the leader of the very country that, ever since 2014, has made the sanctions that they impose on everyone the core of its foreign policy. Iran, Venezuela, Russia, China, the European Union. Such rhetoric may seem serious only for those who are either completely naive or those who are being well paid for demonstrating such naivety. Measures of influence on private companies in any state are always enough: no one can prohibit the federal government of the USA or the governments of individual states from revoking or suspending the license for oil production, for example, because of environmental damage caused by hydraulic fracturing or the burning of associated petroleum gas. However, the fact that the videoconference ends without a result does not mean that all this will end: actually, this is only going to be the beginning of a series of negotiations between everyone and everyone. It has already been officially announced that on April 10th, G20 energy ministers “will discuss measures to mitigate the impact of the coronavirus on energy markets”. This agenda sounds beautiful, and the participation of the States is quite justified. Senators C. Kramer and D. Sullivan said that on April 11th, they intend to “negotiate with officials from Saudi Arabia. To discuss the situation on the world oil market”.
Large fish, large hook
Donald Trump has already declares his intention to maintain protective duties on oil imports, apparently, just out of habit. Such measures will not have a significant impact on Russia’s interests: we did not recall the growth of Urals supplies to China just for the sake of it; Saudi Arabia is actually definitely worried. In March 2016, after almost 20 years of partnership, Saudi Aramco and Shell finally agreed to split the Motiva Enterprises joint venture that was established in 1998, as a result of which Motiva became the 100% daughter company of Saudi Aramco. The company includes several refineries, fuel terminals, as well as structures for the sale of products in the United States. Under the terms of the final agreement, Saudi Aramco obtained the rights to use the Motiva brand, the largest US oil refinery in Port Arthur in Texas and 24 distribution terminals. In addition, Saudi Aramco received the exclusive right to sell Shell brand motor fuels in the states of Georgia, North and South Carolina, Virginia, Maryland, Washington, as well as in eastern Texas and in most of Florida. Motiva’s total refining capacity is of 1.1 million barrels of oil per day, and in May 2017, Saudi Aramco announced its upcoming investments in Motiva amounting to $18 billion with the goal of doubling the production capacity and expanding the gas station network.
This is not Russia’s business in any way, but the gentlemen senators will definitely have something to talk about with said “Saudi officials”. On April 3rd, during a meeting with representatives of the Russian energy sector, Vladimir Putin formulated the conditions under which Russia could agree reduce production: the participation of all interested parties, including the United States. What’s left to do is to wait and see how the events will play out after April 9th, 2020.
Translated by Ellina Hensen
Original text: geoenergetics.ru