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Shock Saudi Move Causes Historic One-Day Plunge in Price of Crude Oil: What Next?

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Pacific Money | Economy

Shock Saudi Move Causes Historic One-Day Plunge in Price of Crude Oil: What Next?

Early on Monday, Brent crude fell by more than 20 percent, dropping to levels unseen since 2015-2016.

Shock Saudi Move Causes Historic One-Day Plunge in Price of Crude Oil: What Next?
Credit: CC0 image via Pixabay

Crude oil prices fell more than 20 percent on Monday, marking the largest one-day downward price movement for the commodity since the 1991 Gulf War. Brent crude, an international crude oil benchmark, dropped as low as $31 from $45 after Saudi Arabia’s state energy firm, Saudi Aramco, prepared to increase crude production.

This crude oil crash is, by any measure, historic, and its effects were felt immediately as markets opened for trading in Asia. Japan’s Nikkei 225 index and South Korea’s KOSPI opened sharply lower — reflecting a mixture of continued concern about the global spread of the coronavirus disease 2019 (COVID-19) and the Saudi moves on oil price.

Saudi Arabia currently produces around 9.7 million barrels per day of crude, but may increase its production capacity to as much as 12 million barrels per day, nearing its maximum capacity of 12.5 million barrels per day. Indication of crude oil price volatility came on Saturday after Riyadh published steep monthly pricing cuts, suggesting it was setting out on a price war.

Underlying current dynamics is an ongoing dispute between Saudi Arabia and Russia. Riyadh has sought to convince Moscow to lower its production. By aggressively lowering the price of crude oil, Saudi Arabia may hope to make continued Russian production less profitable because of Moscow’s higher break-even price.

Russia’s initial interest in increasing oil production was driven by optimism about its domestic production capacity and stocks along with what some perceived to be an opportunity to drive down prices to a moderate level to pressure U.S. producers of shale oil.

At the end of last week, the Organization of Petroleum Exporting Countries (OPEC), a group of 14 countries, met in Vienna to discuss production cuts. Russia refused Saudi demands to cut production, resulting in a breach in the so-called OPEC+ coalition and Moscow’s departure. The meeting — and Saudi Arabia’s aggressive price action in the 48 hours that follow — suggests a broader end to any convergence that existed between Moscow and Riyadh.

Depressed oil prices could severely affect Russia’s national budget given the important role of energy exports in Moscow’s national revenue. It’s unclear how lower oil prices are likely to feed back into what has already been a volatile global economy over the last several weeks owing to a growing loss in global confidence amid concerns about COVID-19.

Lower oil prices may act as a point of pressure on U.S. shale oil producers, but could temporarily increase consumer confidence. For emerging economies in Asia like India, which is a massive net importer of crude oil, the lower prices could provide fiscal breathing room as economic growth slows more broadly.

The immediate effect of the surprising Saudi moves over the weekend may be added volatility, however. The crude oil price drop accompanies dropping U.S. treasury yields and follows a rare 50 basis point interest rate cut by the U.S. Federal Reserve.

The Saudi production increase could be designed to create negotiating leverage with Russia for an eventual deal that could result in reduced output at levels favorable to Saudi Arabia.