Independent oil analyst and author Simon Watkins offered the following opinion on the likelihood and ramifications of oil dropping to the $20/bbl range. Watkins worked for a number of years as a senior Forex trader and salesman, ultimately achieving the positions of Director of Forex at Bank of Montreal and Head of Forex Institutional Sales for Credit Lyonnais. He has since become a financial journalist, being Head of Weekly Publications And Managing Editor and Chief Writer of Business Monitor International, Head of Global Fuel Oil Products for Platts, Global Managing Editor of Research for Renaissance Capital (Moscow) and Head of Developed Market Bond Analysis for Bond Radar.
Since Friday’s shock announcement that Russia was not going to support more oil production cuts from the OPEC+ group, crude has fallen off a cliff to levels not seen since 2016 when Saudi Arabia was trying to destroy the then-nascent U.S. shale oil industry.
It is extremely likely that oil prices will continue to fall, as we have now entered a full-scale oil price war involving the top three oil producers – the U.S., Russia and Saudi Arabia – with huge new volumes of oil coming into the market that will only add to its existing supply overhang and to the soft demand profile resulting from the effects of the coronavirus.
The next serious technical support levels for the Brent crude benchmark are just under US$27 per barrel, then just under US$17 per barrel, and then just under US$10 per barrel. There is no reason at this stage not to expect oil prices to fall to lower than US$20 per barrel. Even the current price of oil means more disaster for Saudi Arabia, which has a budget breakeven price of US$84 per barrel of Brent and has been struggling ever since it failed in its attempts to destroy the U.S. shale sector. Russia’s budget breakeven price is US$40 per barrel of Brent, so it is better placed, whilst most of the best U.S. shale producers can break even above US$35 per barrel.
The U.S. will be the only one of these three producers to benefit from the price drop as it is also a huge consumer of oil, with its economy and politics – especially in an election year – benefitting from lower oil prices.
The risks of a recession in the U.S. have been rising since the coronavirus began to spread more rapidly. According to the statistics, since World War I, the sitting U.S. president has won re-election 11 times out of 11 if the economy was not in recession within 24 months of an election whereas presidents who went into a re-election campaign with the economy in recession won only two times out of seven.
One direct link between oil and the U.S. economy is that as a rule of thumb it is estimated that every USD10 per barrel change in the price of crude oil results in a 25-cent change in the price of a gallon of gasoline. For every 1 cent that the average price per gallon of gasoline falls, more than USD1 billion per year in additional consumer spending is freed up. This stems from the fact that around 70 per cent of the cost of gasoline is derived from the oil price.