Report by S&P Global Ratings
S&P Global Ratings last week lowered its West Texas Intermediate (WTI) and Brent crude oil price assumptions for 2020 by $10 a barrel. Oil price assumptions are unchanged for 2021 and 2022. In addition, we affirmed the Henry Hub and AECO Canadian natural gas price assumptions (see table London 1). These revisions are effective immediately.
We use this price deck to assess sovereign and corporate credit quality, in particular for exploration and production (E&P) companies and for oil-producing countries, in accordance with the ratings methodology described in “How S&P Global Ratings Formulates, Uses, And Reviews Commodity Price Assumptions,” published Sept. 28, 2018.
Over the next several weeks, we will continue to conduct reviews on investment-grade and speculative-grade E&P and oilfield services companies.
Oil markets are heading into a period of a severe supply-demand imbalance in second-quarter 2020. The acute oversupply threatens to test the limits of crude and product storage as soon as May, according to S&P Global Platts Analytics. Spot and futures prices are testing multiyear lows in consequence.
In line with our economic outlook (see “Economic Research: COVID-19 Macroeconomic Update: The Global Recession Is Here And Now,” published March 17, 2020), we anticipate a recovery in both GDP and oil demand through the second half of 2020 and into 2021 as the most severe impacts from the coronavirus outbreak moderate. We believe a material supply response from non-OPEC producers is unlikely until later in 2020. We presently do not assume a significant probability of renewed agreement on OPEC+ supply cuts in the coming months, although this is highly uncertain. Any cuts would need to be much larger than those agreed upon since 2016 to balance the market in the coming months.
This comes at a time when producers, particularly those in North America, are under tremendous pressure by investors to limit spending, maintain positive free cash flow, and enhance shareholder returns. During the previous down cycle in 2015-2016, many producers were successful in significantly reducing their costs and improving their balance sheets through asset sales and equity issuance, which helped reduce the magnitude of rating actions. However, we do not expect producers to achieve anywhere near the efficiencies gained last time. We also believe capital market access will be available only for the strongest issuers. Given negative investor sentiment, capital markets access, and coronavirus concerns, it is likely rating actions in the investment-grade space could be more severe. For the speculative-grade space, especially issuers without hedges, those that face upcoming maturities and are somewhat squeezed on borrowing base revolving credit facilities will most likely face multiple-notch downgrades.
Demand for oil and oil products is already weak and will likely decline materially in second-quarter 2020. The spread of the coronavirus worldwide has resulted in widespread travel restrictions between and within major oil-consuming countries. S&P Global Platts Analytics estimates the growing number of lockdowns could result in an oil demand decline of as much as 14 million barrels per day (b/d) during April and May. Adding this to the additional supply of 2 million-4 million b/d from OPEC+ implies a swing to an imbalanced position equal to 15% or more of global production. This comes after a second relatively mild winter, with lower-than-average heating fuel demand.
Jet fuel typically accounts for about 8%-10% of global oil supply, so with some airlines cancelling most of their flights, we are seeing an immediate demand impact. Diesel and gasoline usage will also increasingly decline as miles driven collapse. Industrial activity in China is now ramping back up after coronavirus-related stoppages in February 2020, signaling the potential for activity and transport to recover over the summer if a comparable pattern emerges elsewhere.
Oil prices plummeted in early March following the failure of the OPEC+ meetings to agree to further production cuts. Russia refused to agree to an additional 1.5 million barrels of production cuts on top of the existing 2.1 million barrels that was set to expire at the end of March. Shortly following the nonagreement, Saudi Arabia surprisingly announced that it was immediately slashing its official selling price and would increase its production above 10 million b/d after the existing production cuts expired at end of March. The Saudis cut their April prices for all crude grades between $6-$8 per barrel.
These actions possibly signal that, despite a collapse in global demand and shrinking physical markets, Russia and OPEC have engaged in a price war to try and maintain market share and market relevance. A price war by OPEC and Russia would clearly target higher-cost producers–typically those in the U.S. The U.S. has become a major player in the global oil markets and a major exporter. It is currently just how high Saudi production will go and for how long. However, it is believed that Saudi Arabia can produce approximately 12 million b/d. It’s possible that Russia and Saudi Arabia could re-engage discussions; however, given the confrontational rhetoric and nature of discussions, we do not expect any to occur.
Russia and Saudi Arabia’s actions are reminiscent of the November 2014 OPEC meeting where OPEC sparked a price war, deciding to maintain production despite oversupply conditions due to increasing oil production from the U.S. OPEC’s goal was to maintain market share while driving many of the U.S. producers out of production. However, OPEC underestimated the ability of U.S. producers to achieve significant efficiencies while increase production. OPEC also underestimated the U.S. bankruptcy courts, which presented U.S. producers the opportunity to reemerge with healthier balance sheets.
We do not expect U.S. production to decline immediately due to hedges and previously drilled wells. Instead, production should begin to be largely affected toward the end of this year and into next as spending levels decline and steep decline curves become impactful.
In the event of a market share grab, we believe Russia has a break-even oil price of approximately $51 per barrel, although Saudi Arabia has a much higher price of $82 per barrel and is in the midst of an economic transformation (Vision 2030) to reduce its reliance on oil. Also, Russia, Saudi Arabia, and several Gulf Cooperation Council (GCC) nations have significant financial resources and can sustain a low oil price environment for some time.