Texas Border Business
By M. Ray Perryman
The price of crude oil has fallen substantially, roiling markets. Let’s look at what has happened and what we might expect going forward.
Since the coronavirus outbreak began, slack has developed in demand for crude oil. Disruptions and quarantines have caused economic growth in China and elsewhere to slow. With the huge Chinese economy expanding less, slower growth has rippled out, and areas with significant outbreaks have experienced even greater negative effects. The result has been falling demand for oil and natural gas, and therefore downward pressure on prices. Early in the year, prices were in the $63 per barrel range; they had fallen to less than $42 by March 6.
Then OPEC+ fell apart, at least for the moment. While OPEC (The Organization of the Petroleum Exporting Countries) dates back to 1960, over the past few years, Russia has been added to the talks and various production agreements. Production cuts were proposed in recent OPEC+ discussions to boost prices, but a disagreement between Saudi Arabia and Russia ended with both sides indicating they would instead increase output.
With oil prices already down due to virus-related disruptions, the decision by the Saudi Arabian government to engage in what is essentially a price war with Russia caused a substantial decline (about 25% in one day, the largest drop since 1991). As I am writing, there has been some subsequent recovery in response to signals that the Saudis and Russians might resume discussions; if either side dramatically increases crude production, it will create a “supply shock” to the oil market, and the result could be further declines (which the market appears to be pricing in already).
Neither Russia (because of inefficiencies in its production) nor Saudi Arabia (because of the social spending that is tied to oil production) can sustain these prices indefinitely, but it remains to be seen when someone blinks. While both nations would like to put pressure on the US industry as it gains market share, the most likely outcome of low prices would not be shrinking US production over time, but rather consolidation with US companies with capital acquiring those who falter. In the meantime, US production costs will continue to decline, making any such efforts ultimately futile.
Until things settle down, there will be tremendous pressure on the industry as capital dries up and profits shrink. Although production costs have fallen dramatically in Texas in recent years, sustained prices at current levels could lead to notable near-term disruptions in the state economy. It is not practical for Saudi Arabia or Russia to sustain the current situation for long, but the timing of the truce may depend as much on extraneous factors as it will economics.
Dr. M. Ray Perryman is President and Chief Executive Officer of The Perryman Group (www.perrymangroup.com). He also serves as Institute Distinguished Professor of Economic Theory and Method at the International Institute for Advanced Studies.