Raymond James Update on March :
"The oil market meltdown year-to-date, and especially last week, has been epic in scale and unmitigated in harshness. The fact that global equity
markets have entered an outright bear market hardly makes the oil crash "feel" any better. Today we are slashing our 2020 oil price forecast for
the third time in three months. Our oil price update from February 24 took into account an initial estimate of COVID-19's impact on oil demand,
focusing on the epicenter in China. Since then, the situation in China has stabilized, but in Europe and the U.S. there is huge deterioration. This
alone would have been enough for us to revisit our price deck. But demand headwinds are only part of the story. The crescendo of oil's collapse,
last Monday, was due to the supply side of the equation: Saudi and Russia abruptly walked away from talks regarding production cuts, effectively
starting a price war. So, are things bad? Of course. But are they hopeless? No. Here are three points that may be getting overlooked amid what
is surely the worst energy sector sentiment ever.
> First, the cure for low oil prices is low oil prices, and next year we are forecasting a meaningful
decline in U.S. production (and in other short-cycle producing countries as well).
> Second, the Saudi-Russia price war is largely political, and also
self-destructive, so we expect it to be short-lived.
> Third, as hard as it may be to believe now, COVID's demand impact will also subside over time. All
that being said, make no mistake, we expect the oil market to get much worse in the near-term (WTI likely tests $20/Bbl in 2Q) before rebounding
strongly in the second half of 2020 (exiting the year at $45+)."
Oil Price Forecast - March 17
Oil Price Forecast - March 17
Dan Steffens
Energy Prospectus Group
Energy Prospectus Group
Re: Oil Price Forecast - March 17
More from the same RJ energy sector update:
Saudi vs. Russia: The straw that broke the camel's back for oil prices is self-destructive for both sides, and Saudi will likely blink first.
The Saudi/Russia price war has tanked the market, even though the rhetoric feels overdone. For oil prices and energy stocks alike, one of
the most violent sell-offs in history took place on Monday, March 9. The previous Thursday, March 5, OPEC had proposed an extended production
cut of 1.5 million bpd, contingent on Russia's participation, but on March 6 Russia refused. The fight between Saudi and Russia – the two had
collaborated, albeit uneasily, as part of the OPEC+ coalition over the previous three years – turned even nastier on March 7. Saudi offered
wider than-normal crude discounts to European buyers and also signaled that it will increase output to 10-11 million bpd in April, up from the current
level of 9.7 million bpd. In other words, welcome to a new price war. Subsequently, rhetoric from Saudi leadership suggested that it could even
ramp to more than 12 million bpd. To be clear, we highly doubt that this is technically feasible for an extended period of time, bearing in mind that
Saudi has never exceeded 10.8 million bpd on a quarterly basis. Flushing tanks would create a brief, artificial production surge, but with Saudi
inventories already at multi-year lows, sustaining that would be a far-fetched proposition. In fact, even attempting to push reservoirs overly hard
can create serious risks for field safety and integrity.
To clarify, this price war is NOT against U.S. shale – this is a key contrast versus the 2014-2016 price war. Saudi can see perfectly well what
has been happening in the U.S. oil industry: the already depressed rig count and sharply slowing production growth. Rather, what is currently
taking place represents an “intra-mural” fight between Saudi and Russia. The fight is partly economic – hence the no-deal outcome at the OPEC+
meeting - bearing in mind that Russia had never actually fulfilled its obligations as part of the OPEC+ cuts, even when it had pretended (on paper)
to be a partner. More importantly, though, the fight is deeply political. A date we will be watching closely is April 22 - less than six weeks away -
this being a below-the-radar, seemingly esoteric, but important catalyst. That day, Russia will have a major constitutional referendum, arguably
the most sensitive moment in domestic politics during Vladimir Putin's 20 years in power. Among the issues at stake is whether Putin can run for
the presidency yet again, in 2024. In the run-up to the referendum, the Kremlin is stirring up nationalist fervor at home, and that translates into
more intransigence than usual in foreign policy. Even during their three-year "marriage of convenience", Saudi and Russia have never stopped
being at loggerheads over Iran (Russia is friendly with Tehran, for Saudi it is enemy number-one) and Syria (Russia backs the Assad regime, Saudi
helps fund the rebels).
So, how long can Saudi and Russia keep this up? In our view, not long - especially because of pressures on the Saudi side. Our base case
assumption is that Saudi will flood the market in 2Q, producing a record 11.3 million bpd. Then, as the two sides presumably get back to the
negotiating table, we assume that a decision to end the price war will be announced in May or June. This implies that Saudi production will get
back to a more rational level - we are modeling 9.8 million bpd - starting in 3Q. (As a practical matter, Russian production is already near max
levels - Russia has no spare capacity to speak of, and production growth has been remarkably stable at 1% per year over the past decade.)
There are three reasons for our view that the price war will be a short-lived phenomenon: much shorter than the approximately two-year duration of
the previous one.
● First, as noted earlier, for domestic political reasons the Kremlin should be more receptive to a deal by the summer.
● Second – and this is an important distinction versus 2014-2016 – Aramco is a public company. The vast majority of the shareholders who
bought on the IPO in December 2019 are Saudi citizens. Does the crown prince and the other royals want to deal with angry domestic investors
who are seeing losses from the IPO price? And how much more pain would Aramco shares experience if the price war lingers? This factor, a
key test of the royal family's credibility, did not exist four or five years ago. It would surely be a PR embarrassment, if nothing else, to continue
watching Aramco's market cap dwindle.
● Third, and most importantly, Saudi needs approximately $70 Brent to balance its all-in fiscal requirements.
Below we are revisiting our math for this fiscal breakeven, an analysis that we have published before, though not in such extraordinary times.
Here is another way to frame Saudi's sensitivity to oil prices.
At current strip pricing, we estimate that the Saudi treasury would have to draw $120 billion per year from
foreign currency reserves, which currently stand (based on official data) at $500 billion. While Saudi would not literally go bankrupt even if the
price war were to last for the next 12 months, we find it hard to believe that the royal family would risk the sovereign balance sheet over what
is ultimately a self-defeating, self-destructive game against Russia. As far as Russia itself, it has the advantage of a having a more diversified
economy than Saudi. Russia is undoubtedly feeling pain as well - take a look at the year-to-date chart of the ruble's exchange rate - but Saudi
is the side that is more likely to blink first in this test of wills.
Saudi vs. Russia: The straw that broke the camel's back for oil prices is self-destructive for both sides, and Saudi will likely blink first.
The Saudi/Russia price war has tanked the market, even though the rhetoric feels overdone. For oil prices and energy stocks alike, one of
the most violent sell-offs in history took place on Monday, March 9. The previous Thursday, March 5, OPEC had proposed an extended production
cut of 1.5 million bpd, contingent on Russia's participation, but on March 6 Russia refused. The fight between Saudi and Russia – the two had
collaborated, albeit uneasily, as part of the OPEC+ coalition over the previous three years – turned even nastier on March 7. Saudi offered
wider than-normal crude discounts to European buyers and also signaled that it will increase output to 10-11 million bpd in April, up from the current
level of 9.7 million bpd. In other words, welcome to a new price war. Subsequently, rhetoric from Saudi leadership suggested that it could even
ramp to more than 12 million bpd. To be clear, we highly doubt that this is technically feasible for an extended period of time, bearing in mind that
Saudi has never exceeded 10.8 million bpd on a quarterly basis. Flushing tanks would create a brief, artificial production surge, but with Saudi
inventories already at multi-year lows, sustaining that would be a far-fetched proposition. In fact, even attempting to push reservoirs overly hard
can create serious risks for field safety and integrity.
To clarify, this price war is NOT against U.S. shale – this is a key contrast versus the 2014-2016 price war. Saudi can see perfectly well what
has been happening in the U.S. oil industry: the already depressed rig count and sharply slowing production growth. Rather, what is currently
taking place represents an “intra-mural” fight between Saudi and Russia. The fight is partly economic – hence the no-deal outcome at the OPEC+
meeting - bearing in mind that Russia had never actually fulfilled its obligations as part of the OPEC+ cuts, even when it had pretended (on paper)
to be a partner. More importantly, though, the fight is deeply political. A date we will be watching closely is April 22 - less than six weeks away -
this being a below-the-radar, seemingly esoteric, but important catalyst. That day, Russia will have a major constitutional referendum, arguably
the most sensitive moment in domestic politics during Vladimir Putin's 20 years in power. Among the issues at stake is whether Putin can run for
the presidency yet again, in 2024. In the run-up to the referendum, the Kremlin is stirring up nationalist fervor at home, and that translates into
more intransigence than usual in foreign policy. Even during their three-year "marriage of convenience", Saudi and Russia have never stopped
being at loggerheads over Iran (Russia is friendly with Tehran, for Saudi it is enemy number-one) and Syria (Russia backs the Assad regime, Saudi
helps fund the rebels).
So, how long can Saudi and Russia keep this up? In our view, not long - especially because of pressures on the Saudi side. Our base case
assumption is that Saudi will flood the market in 2Q, producing a record 11.3 million bpd. Then, as the two sides presumably get back to the
negotiating table, we assume that a decision to end the price war will be announced in May or June. This implies that Saudi production will get
back to a more rational level - we are modeling 9.8 million bpd - starting in 3Q. (As a practical matter, Russian production is already near max
levels - Russia has no spare capacity to speak of, and production growth has been remarkably stable at 1% per year over the past decade.)
There are three reasons for our view that the price war will be a short-lived phenomenon: much shorter than the approximately two-year duration of
the previous one.
● First, as noted earlier, for domestic political reasons the Kremlin should be more receptive to a deal by the summer.
● Second – and this is an important distinction versus 2014-2016 – Aramco is a public company. The vast majority of the shareholders who
bought on the IPO in December 2019 are Saudi citizens. Does the crown prince and the other royals want to deal with angry domestic investors
who are seeing losses from the IPO price? And how much more pain would Aramco shares experience if the price war lingers? This factor, a
key test of the royal family's credibility, did not exist four or five years ago. It would surely be a PR embarrassment, if nothing else, to continue
watching Aramco's market cap dwindle.
● Third, and most importantly, Saudi needs approximately $70 Brent to balance its all-in fiscal requirements.
Below we are revisiting our math for this fiscal breakeven, an analysis that we have published before, though not in such extraordinary times.
Here is another way to frame Saudi's sensitivity to oil prices.
At current strip pricing, we estimate that the Saudi treasury would have to draw $120 billion per year from
foreign currency reserves, which currently stand (based on official data) at $500 billion. While Saudi would not literally go bankrupt even if the
price war were to last for the next 12 months, we find it hard to believe that the royal family would risk the sovereign balance sheet over what
is ultimately a self-defeating, self-destructive game against Russia. As far as Russia itself, it has the advantage of a having a more diversified
economy than Saudi. Russia is undoubtedly feeling pain as well - take a look at the year-to-date chart of the ruble's exchange rate - but Saudi
is the side that is more likely to blink first in this test of wills.
Dan Steffens
Energy Prospectus Group
Energy Prospectus Group