BAKU, Azerbaijan, March 18
By Leman Zeynalova - Trend:
Saudi Arabia will reverse course, paring back production and allowing prices to recover, Fitch Solutions Country Risk and Industry Research (a unit of Fitch Group) believes.
“The pursuit of maximum market share will put the kingdom under severe fiscal strain. Its fiscal breakeven is high, estimated at around $86 per barrel in 2019 by the IMF. More conservative spending and an increase in production will provide some offset, but the offset will be limited when compared to around 50 percent reduction in annual average oil prices (and more so given that its currency is pegged). Saudi Arabia boasts large fiscal reserves and a low debt-to-GDP ratio and could, we estimate, sustain its budget deficit for around five to eight years, depending on spending levels, oil prices and so on. However, given the primacy of the social contract, it will be unwilling to cut down on its spending too aggressively, or run down its reserves too deeply. This puts a time limit on any price war. Assuming that Russia refuses to alter its position, we expect the kingdom will reverse strategy over 2021 to 2022,” the company said, Trend reports.
Fitch Solutions expects that 2020 will mark the nadir, as OPEC and Russia flood the market.
“Not all of the barrels cut under the OPEC+ deal can be returned, with some lost permanently as a result of mature asset declines, spending pullbacks and other marketspecific factors. However, the majority can. Estimated calculations suggest that around 3.5-4 million barrels per day could returned by the end of April, equivalent to more than three years of global oil demand growth,” reads the report.
Growth of this scale is historically unprecedented and will overwhelm the market, the company believes.
“Inventories will balloon and prices will face renewed and severe downside pressure. The rate of inventory build will depend on a host of factors, not least where sustainable production levels lie for OPEC and Russia, how non-OPEC producers respond to the price drop and the pace at which demand recovers from Covid-19. However, it is difficult to construct any scenario under which inventories build by less than a billion barrels by year end. Storage capacity is limited and will rapidly become exhausted, should Saudi Arabia, Russia, the UAE maintain their planned levels of production,” said Fitch Solutions.
The company expects that shale production declines and well shut-ins among higher cost producers will help to rebalance the market from 2021.
“We are still in the process of modelling how shale production may respond under various price scenarios, but under all scenarios we expect a more immediate response than was seen in 2014. Companies across the patch are announcing large reductions in capex and drilling, which will begin to drag on growth rates within the second quarter and will likely see production turn negative within the year. Cost cutting measures, asset high grading, production hedges and US Strategic Petroleum Reserve (SPR) purchases will provide a measure of protection,” the report says.
Nevertheless, the drop in production growth will be steep and financial risks are severe, according to Fitch Solutions.
“The sector had already shown signs of strain before Covid-19 and OPEC+ collapsed the oil price. The rate of bankruptcies was rising over 2019, equity price performance was generally weak and, for some companies, access to capital markets was drying up. Financial vulnerability varies widely across the shale patch, but the loss of the capital market crutch will see many players enter bankruptcy. When the shale sector emerges from the downturn, it will be more consolidated, with a greater skew towards the majors and larger independents. The pace of growth will likely be more subdued, but the cost base lower and production more resilient to future downturns.”
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