[Editor's note: A version of this story appears in the April 2020 edition of Oil and Gas Investor. Subscribe to the magazine here.]

Hart Energy hosted its Energy Capital Conference on March 2 amid much sober sentiment after the steepest one-day stock market drop since 2008 and a 16% plunge in WTI crude the prior week. However, the one-day conference saw a robust rebound: the Dow Jones index up over 1,200 points, a gain of over 5%, and crude up almost $2 to $46.75/bbl.

The saying is, “You take what market gives you.” But energy came up empty, and far worse days lay ahead.

The E&P sector failed to participate on the day of the conference, with the S&P Oil & Gas Exploration & Production ETF (XOP) trading flat on the day and drifting down around 3.5% over the next two days. Even those short energy stocks apparently felt little urgency to cover. After all, who wanted to wager ahead of an OPEC meeting where Russia seemed to be dragging its feet in support of a key Saudi proposal?

One observer cited three potential outcomes: “very bearish, bearish and mildly bearish.” He was right.

Ultimately, the Russian delegate rebuffed plans for a cut of 1.5 million barrels per day (MMbbl/d), of which core OPEC members would have cut 1 MMbbl/d and OPEC+ members the remaining balance. The proposal was aimed at offsetting a build in inventories due to the coronavirus, which had already crushed demand for crude during a seasonally weak period exacerbated further by a warm winter.

Where the meeting disintegrated into disarray was the absence of a back-up agreement, or “plan B,” and then a good deal of rancor between Russia and Saudi Arabia. Having failed to reach an agreement, Saudi Arabia indicated it would boost output to 10- to 11 MMbbl/d, up from 9.7 MMbbl/d, as the prior OPEC system of quotas expired on April 1 with nothing to replace it.

Saudi Arabia swiftly cut official selling prices (OSP) for its benchmark Arab Light grade by $6/bbl—said to be its largest monthly cut in records going as far back as 2003—to Asian customers that make up about two-thirds of its exports. The Arab Light OSP for Northwest Europe was cut by $8/bbl to a $10.25 discount to Brent, while U.S. buyers saw at $7/bbl cut to a $3.75 discount to the Arhus Sour Crude Index.

In the first day of U.S. trading after the failed deal, WTI settled down $10.15 at $31.13/bbl, while Brent was down $10.91 at $34.36/bbl. Analysts expect prices to hover around these levels, with Goldman Sachs forecasting Brent to average $35/ bbl for the second and third quarters, with possible dips to $20/bbl. Morgan Stanley predicted WTI at $30/bbl in the second quarter and $35 to $40 in the second half.

Bernstein analyst Neil Beveridge predicted the U.S. E&P sector would see a “wave of bankruptcies” in the wake of Saudi Arabia’s switch away from what was a policy of supporting oil prices to one focused on a “battle for market share.” In addition, the impact on the oilfield service sector would be “devastating.”

More leveraged E&Ps, especially those facing maturities in an already highly dislocated high-yield market, are obviously most at risk if crude prices stay at sharply depressed levels. But entire economies may also be under stress. Saudi Arabia has a fiscal breakeven $83.60/bbl, while Libya and Algeria have breakevens of around $100/bbl and Iran over $190/bbl, according to Credit Suisse data.

The largely unexpected Saudi-Russian schism drove a steep drop in equity markets. The Dow fell by over 2,000 points, marking anew its worst day since 2008. E&P stocks were crushed, with the XOP down over 35%. With the lower oil prices, U.S. drilling and completion capex for 2020 is forecast to be down 35%, according to Tudor, Pickering, Holt & Co.

Reasons for Russian intransigence on further production cuts are not fully clear. Some pointed to possible attempts by Russia to impair U.S. shale production in a retaliatory move. Earlier, the U.S. had blacklisted the trading arm of Russia’s Rosneft in its moves to export Venezuelan crude. In addition, the U.S. worked to prevent the completion of the Nord Stream 2 Pipeline.

Bernstein pointed to major costs for Russian producers being denominated in rubles, whereas revenues are generally generated in dollars. This makes Russia “effectively vaccinated against low oil prices,” it said.

Importantly, Russia is reported to have a fiscal budget based on a $42/bbl Brent breakeven price. Whatever the reason, the risks are clear: Brace yourself for another ongoing market share war.

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