Timing is everything and surprisingly, Saudi Arabia initiated an oil price war with Russia at a time when the world is dealing with the coronavirus outbreak. As demand started to fall off a cliff, the Kingdom decided that it would reduce supply as the coronavirus started decimating supply chains, inducing social distancing and grounding flights. Crude oil prices have tumbled which is likely an issue for most of OPEC but works withing the construct of what the Saudi’s are trying to accomplish.

What Occurred
Saudi Arabia and Russia have been trying to buoy crude oil prices during the past three years but the two had a falling out over Riyadh’s demand that OPEC+ agree to cut oil supplies by 1.5 million barrels a day. This came as the coronavirus was spreading through Europe and had just showed up on US shores. The underlying reason was that China, the biggest importer of oil, was turning back tankers as the coronavirus outbreak stalled the Chinese economy. Additionally, Russia was unhappy with the increase in US production which had recently reached an all-time high of 13.1-million barrels a day.

The Saudi Action
Saudi Arabia, was unhappy with the Russian response and decided that it would embark upon a full price war, driving both Russian and US producers out of business. The upshot is that oil experienced a huge 30% drop in prices experiencing the biggest one-day crash since the 1991 Gulf War. Prices breached the $30 per barrel level and could continue to decline if an agreement is not reached. While both nations will likely be able to handle a price war, Saudi Arabia may need to borrow money to fill the gap between what it spends and the revenue it receives.

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With the US Feel Pain
The fallout of the drop in prices will impact US producers significantly. Most US producer that engage in fracking, which is a process that sends water and sand into the ground an breakup shale, have costs that are approximately $50 per barrel. While there are some that claim they can produce as low as $30 in the US, the average according to Reuters is $50 per barrel. If you trade stocks of US energy producers you have seen the destruction seen in those share prices.

A drop in WTI prices below $30 per barrel, will cause some US producers to go out of business. Initially, many will continue to pump with the hope that prices will rise, but until drilling rigs begin to decline, prices will stay at current levels unless the Saudi Arabia begins to reduce production.

According to oil service giant Baker Hughes, the number of oil rigs increased for the week, by 1 rig, bringing the total to 683. This is a decline of 150-rigs year over year. Unfortunately, it is well of the lows experience in 2016, the last time oil prices hit this level. The number of oil rigs in the Permian basin where most of the US oil is produce, rose by 3 this week to 418, compared to 464 rigs one year ago. This compares to a rig count of 316, which was the low hit in 2016 when prices last pierced through the $30 per barrel level.

The bottom line is that oil prices remain under pressure and need some form of outlet. This either includes a massive decrease in the production in the US, or an agreement between Saudi Arabia and Russia that will put back production.