No agreement was reached at the OPEC+ production reduction meeting, and there was an avalanche in international oil prices. Looking back at several oil price slumps in history, where will the crude oil market go? Do you want to continue to bottom out or quickly return to cost support? The analysis says three major issues need to be paid attention to.

With the avalanche of international oil prices, Brent crude oil futures fell by more than 30% at one point. The following is GF Securities Co., LTD. 's analysis of the collapse in oil prices:

Event: OPEC+ production reduction meeting did not reach an agreement, crude oil market continues to bottom out

No agreement was reached at the OPEC+ production reduction meeting, and the price of crude oil fell sharply. Since the beginning of 2020, affected by the COVID-19 epidemic, the market is pessimistic about global economic growth and the corresponding growth of global crude oil demand, which leads to a sharp drop in international crude oil prices. The market hopes that an agreement on production reduction can be reached at the OPEC+ meeting on March 5-6, which will continue to deepen the production reduction on the basis of the existing production reduction and alleviate the supply and demand pressure caused by the epidemic. However, according to Reuters and other media reports, no agreement was reached in the OPEC+ production reduction talks, and international crude oil prices fell sharply after the results of the meeting.

First, taking history as a mirror, a review of several sharp falls in oil prices in history

1. 1998: the largest decline of 61%, the Asian financial crisis

The reason for the collapse in oil prices: the outbreak of the Asian financial crisis in 1998 led to a slowdown in global economic growth. In 1998, global economic growth slowed to 2.5% from 4.18% in the previous year, and global oil demand growth slowed to 0.5%.

The time and extent of the decline in oil prices: from January 1997 to December 1998, the price of Brent crude oil fell from a high of 24.80 US dollars per barrel to 9.75 US dollars per barrel, with the largest drop of 61 per cent.

The reason for the rebound in oil prices: OPEC cut production twice in April and July 1998, by 1.25 million b / d and 1.335 million b / d respectively, and the global economy bottomed out after the financial crisis.

The late trend of oil prices: oil prices began to pick up in March 1999, and crude oil prices returned to their pre-falling highs by the end of 1999.

2. 2001: the largest decline of 40%, the bursting of the Internet bubble caused the global economic recession

The reason for the collapse in oil prices: the dotcom bubble burst in 2001, the global economy slowed down, the three major economies of the United States, Europe and Japan slowed at the same time, the 9.11 incident caused damage to the US economy, and the growth of global crude oil demand was less than 1% in a row. At the same time, driven by the increase in the production of OPEC countries, the growth rate of global crude oil production reached 4.32% in 2000, and the market fell into an oversupply.

The timing and extent of the decline in oil prices: between September 2001 and November 2001, the price of Brent crude fell from a high of 29.43 US dollars per barrel to 17.68 US dollars per barrel, with the largest drop of 40 per cent in the range.

The reason for the rebound in oil prices: OPEC twice announced production restrictions and insurance prices, announced a production reduction of 3.5 million b / d in September 2001, and another 1.5 million b / d in January 2002. Non-OEPC countries, including Russia, also pledged to cut production by 460000 b / d; the growth rate of oil demand rebounded sharply after the crisis.

Late trend of oil prices: oil prices bottomed out and rebounded in February 2002, and oil prices basically returned to their pre-slump levels in May.

3. 2008: maximum decline of 75%, global financial crisis

The reason for the collapse in oil prices: the outbreak of the global financial crisis, the cliff decline in economic growth, and the negative growth of global crude oil demand for two consecutive years, with a year-on-year growth rate of-0.39% in 20018 and-1.68% in 2009.

The timing and extent of the fall in oil prices: Brent crude fell from a record high of $144.49 a barrel to a low of $36.61b between July and December 2008, the biggest drop of 75 per cent in the range.

The reason for the recovery of oil prices is that OPEC has reduced production for three times: 520000 b / d in September 2008; 1.5 million b / d in October 2008; and 2.2 million b / d in December 2008. Governments of various countries have actively rescued the market, implemented quantitative easing policies, and the economy has gradually stabilized.

Late trend of oil prices: crude oil prices rebounded quickly after bottoming out at the end of 2008, returning to $60 / barrel in May 2009 and then back to a high of $120 / barrel in May 2011.

4. The largest decline in 2014-2016 was 76%, shale oil shock.

The reason for the collapse in oil prices: rapid growth in shale oil production, OPEC refused to cut production, chose to increase production to try to squeeze shale oil out of the market, the lifting of US economic sanctions on Iran, coupled with the slowdown in crude oil demand growth, led to loose global supply and demand and a substantial accumulation of explicit crude oil stocks.

When oil prices fell: Brent crude fell from $115.06 a barrel to $27.88 a barrel between June 2014 and January 2016, the biggest drop of 76 per cent in the range.

The reason for the rebound in oil prices: OPEC and Russia and other oil-producing countries have formed an alliance to reduce production by 1.8 million barrels per day since 2017, and the alliance has been going on ever since.

Late trend of oil prices: crude oil prices slowly rebounded after bottoming out in 2016. With the implementation of the production reduction agreement, the recovery of crude oil demand and the removal of crude oil stocks, Brent crude oil prices returned to $70 per barrel at the beginning of 2018.

5.2018: the largest decline of 41%, trade disputes superimposed the impact of OPEC production

The reason for the collapse in oil prices: the trade dispute between China and the United States has escalated, and major institutions have revised their economic growth forecasts; major oil-producing countries have continued to increase production to deal with the supply gap caused by US sanctions on Iran, but the pace of US sanctions on Iran has been lower than expected. International oil prices have fallen sharply amid fears of oversupply.

The timing and extent of the decline in oil prices: from October 2018 to December 2018, the price of Brent crude oil fell from a high of $85.00 per barrel to $50.47 per barrel, the largest drop of 41 per cent.

The reason for the rebound in oil prices: OPEC+ reached an agreement to cut production by 1.2 million b / d, OPEC+ production reduction exceeded market expectations in the first quarter, and active production reduction was strongly enforced. Coupled with the economic sanctions imposed by the United States on Venezuela and Iran, the supply side of the crude oil market contracted beyond market expectations. On the demand side, trade disputes eased in stages, and the economic growth rates of China and the United States exceeded market expectations.

Later trend of oil prices: trade disputes between China and the United States continued, US shale oil production continued to grow, and crude oil prices fell back to the range of 55-70 US dollars / barrel again after returning to more than 70 US dollars per barrel in April 2019.

Second, taking history as a mirror, how does the collapse in oil prices in history end?

(1) the imbalance between supply and demand leads to a sharp fall in crude oil prices, the supply-side collapse in oil prices often takes longer to repair, and the demand-side collapse in oil prices takes less time to repair.

(2) the collapse in oil prices caused by the supply side can be referred to in 2014-2016, which lasts for a long time and takes a long time to digest the market surplus, so the crude oil suppliers need to balance with the new suppliers in the new oil prices. OPEC and Russia, as the traditional main suppliers, are not willing to reduce production in the process of old and new games, because the loss of market share is likely to be permanent.

(3) the collapse of oil prices caused by demand-side can be referred to in 1998, 2001 and 2008, the collapse of oil prices caused by demand-side can often quickly trigger the supply-side to take the initiative to reduce production, but the recovery of crude oil prices often need to reach the bottom and stabilize. The collapse in oil prices on the demand side is often due to a short-term and severe financial market crisis, in which central banks around the world are likely to cut interest rates to release liquidity. The liquidity released becomes the driver of the rise in crude oil prices in the process of demand bottoming and recovery, accelerating the rise in oil prices, and the final recovery of crude oil prices can be more rapid, and the height of the recovery is often up to or even higher than the level before the decline.

Third, the OPEC+ production reduction agreement has not been reached, where will the crude oil market go?

The failure of this production reduction agreement will have a more complex impact on the subsequent trend of the crude oil market, which has responded to the failure of this production reduction agreement with a sharp fall in prices in the short term. At present, after falling below what we think is the cost support position of shale oil, the uncertainty about the future trend of crude oil prices begins to increase. In the end, is it to continue to bottom out or quickly return to cost support? We believe that in order to analyze the impact of the failure of this deepening production reduction agreement on the future, we need to answer the following questions:

1. What are the fundamentals of supply and demand at the current time?

two。 Why did the agreement on deepening production reduction fail to be reached?

3. This agreement does not agree on the possible evolution direction of the follow-up events?

1. What is the fundamental pressure of supply and demand at the current time?

Economic expectations are pessimistic, while demand expectations are as pessimistic as in 2008. Affected by the global spread of COVID-19, the global market forecast for economic growth in 2020 has generally been lowered, and the forecast is more pessimistic. According to the report of the Oxford Institute of Economics, if the COVID-19 epidemic is limited to the short-term impact of China, the global GDP growth rate will fall by 0.2% compared with the benchmark in 2020. If the epidemic spreads in Asia, the global GDP growth rate will decline by 0.5% (US $400 billion) compared with the benchmark in 2020. If the epidemic spreads globally, the global GDP growth rate will decline by 1.3% (US $1.1 trillion) in 2020. And global economic growth is likely to slow to zero in the first half of the year. Us Treasury yields have fallen sharply recently, with the real yield on 10-year Treasuries falling to-0.57 per cent and the yield on 2-year Treasuries falling to 0.49 per cent. The sharp drop in US Treasury yields also reflects market pessimism to some extent.

The impact of the epidemic on China's crude oil demand has been shown, but the impact on the global economy and the epidemic is still in the expected stage. Judging from the current supply and demand situation, the impact of the epidemic on China's crude oil demand has been shown, and the dark moment has passed, the future demand has gradually recovered, and the operating rate of domestic main refineries and local refineries in Shandong has gradually rebounded. The answer is that the impact of the epidemic on the global economy and crude oil demand is still in the expected stage, and the epidemic outside China has accelerated since late February, and overseas economic data and crude oil data have not yet reflected the impact of the epidemic.

Global explicit inventory is still in the normal range, and the inventory pressure is less than the 14-16 year decline. Judging from the current explicit inventory data indicators, the explicit inventory level in the core reservoir areas of the world is still in the normal range. Us crude oil inventory, Rotterdam crude oil inventory and Japanese crude oil inventory are all at reasonably low levels. From the perspective of US crude oil inventory, the current pressure on crude oil inventory is significantly less than that in 2016.

Several countries with more confirmed cases account for about 23.6% of global crude oil demand. According to the data of the BP Statistical Yearbook in 2018, the annual global consumption of crude oil is about 4529 million tons, of which China consumes 628 million tons, accounting for 13.9 percent; Japan 176 million tons, accounting for 3.9 percent; South Korea 122 million tons, accounting for 2.7 percent; Iran 82 million tons, accounting for 1.8 percent; Italy 59 million tons, accounting for 1.3 percent; the United States 893 million tons, accounting for 19.7 percent. Currently, a large number of confirmed cases include China, South Korea, Italy, Iran and Japan, which together account for 25.2% of the global crude oil demand.

two。 Analysis of the reasons for the failure to reach the agreement on deepening production reduction

The failure to reach this deepening production reduction agreement caught the market by surprise. We analyze the main reasons why this deepening production reduction agreement failed to be reached are as follows:

1. At present, the fundamentals of supply and demand are stronger than expected, and the epidemic situation in China is gradually under control.

2. After many games, the oil price tested the production cost of shale oil again, and the growth power of shale oil began to weaken.

3. After 16-20 years of recovery, Russia's finance has eased. At present, the oil-producing countries in the Middle East that are more willing to reduce production are more willing to reduce production, so Russia is unwilling to undertake more production reduction tasks.

The demand for crude oil is stronger than expected, and the epidemic in China has been gradually brought under control. At present, from the analysis of realistic crude oil fundamentals, there are obvious signs of deterioration in the explicit inventory data in all regions outside China, while domestic refineries with high inventory and start-up pressure are also gradually coming out of the trough and entering the stage of gradual increase in start-up load. the domestic epidemic situation is gradually under control and downstream demand is recovering steadily. Overseas countries have not adopted such closed measures at home, so the decline in demand is expected to be longer than at home, but the intensity may be more moderate. Under this combination of strong reality and weak expectations, there is a panic overfall in the current oil price, so the balance sheet of supply and demand that has not been obviously damaged does not need to be repaired by drastic production cuts. at this time, production cuts will increase oil prices and lose more market share at the same time.

Current oil prices fall below the average production cost of shale oil core blocks in the United States. According to the data of BTU Analytics, the current balance cost of shale oil core blocks in the United States is between 32.4 and 57.4. except for the low balance cost of initial East Eagle Ford, the production costs of other core blocks are all above 44 US dollars per barrel, which is already higher than the current WTI futures settlement price. According to the data from the Dallas Fed survey in March 2019, the current WTI oil price is already lower than the average new well profit cost of US shale oil blocks. If crude oil prices remain at the current position, the incentive to increase production of US shale oil will be greatly weakened.

After the collapse in oil prices in 2018, US shale oil has shown signs of decelerating. From the perspective of shale oil production growth, shale oil production growth continues to decline after the high point in mid-2018, and the inflection point of Permian production growth in the core block is basically consistent with the inflection point of shale oil production growth. According to EIA data, crude oil production in the core shale oil producing areas of the United States increased by 12.0% in March 2020 compared with the same period last year, and the growth rate continued, which is significantly slower than the 18.4% growth rate in the same period last year. In fact, we can find that there has been a slowdown in the growth of US shale oil production since the sharp fall in crude oil prices in October 18, even if crude oil prices bounce back to the central shock in 2019. The growth of US shale oil is still in a decelerating trend.

With the recovery of oil prices from 2016 to 2020, the financial pressure on Russia has eased somewhat. We guess that in the current position of crude oil prices, Russia is not afraid of low oil prices. The possible reason is that in this round of crude oil price recovery in 2016-2019, Russia's financial pressure has eased to a certain extent compared with 2016, so in terms of fiscal adjustment capacity, it has the ability to continue to maintain fiscal operation in a period of low oil prices.

Countries in the Middle East are facing greater financial pressure and stronger demands for oil prices. According to IMF forecasts, the oil price in Saudi Arabia's fiscal balance will be about $83.60 per barrel in 2020 and $55.30 per barrel in current account balance. The current price of the OPEC basket of crude oil is lower than the fiscal balance cost of almost all Middle Eastern oil-producing countries, as well as the current account break-even cost of most oil-producing countries. Moreover, in the past few years, the price of crude oil has for a long time been lower than the fiscal balance cost of major oil-producing countries such as Saudi Arabia. in fact, the major oil-producing countries in the Middle East have greater financial pressure and stronger demand for oil prices. therefore, Russia may not be willing to undertake more production reduction tasks when the financial pressure is less than that of the oil-producing countries in the Middle East.

3. What is the development direction after deepening the production reduction without reaching an agreement?

In the near future, there are two demand scenarios and three supply scenarios. After deepening the production reduction without reaching an agreement, there is more uncertainty about the trend of the crude oil market. We believe that there are two development directions for the demand side in the future:

• (1) the global epidemic is out of control, pessimistic expectations turn to reality, and economic growth is more affected.

• (2) the global epidemic situation is under control. In this scenario, the epidemic situation in China is likely to be controlled earlier than the global epidemic situation.

On the supply side, we believe that the core of the uncertainty is the recent production reduction alliance between OPEC and Russia, and the long-term changes in production in the United States. There are three possible development directions in the near future.

• (1) the new production reduction agreement has not been reached, the existing production reduction agreement expires in March, and the OPEC+ production reduction alliance is essentially broken.

• (2) the new production reduction agreement has not been reached, the existing production reduction agreement has been extended, and the OPEC+ production reduction Alliance continues to maintain cooperation.

• (3) OPEC and Russia have renegotiated recently and reached a new round of agreement on deepening production reduction.

The upper combination:Demand is expected to improve and supply is expected to improve. The most favorable combination for crude oil prices is that the global epidemic has been brought under control, demand is expected to improve, and supply-side OPEC has re-reached a deeper production reduction agreement with Russia. If subsequent events follow this combination, crude oil prices will recover rapidly, and driven by supply and demand and liquidity, crude oil prices will quickly return to high levels. If you take into account the continuing civil unrest in Libya, according to the current supply and demand, Brent crude oil price center is expected to rise above 65 US dollars per barrel.

Middle and upper combination:Demand is expected to improve and supply is expected to maintain. If the epidemic situation in China is controlled in the near future, and the demand is rapidly replenished, the development of the global epidemic is gradually mild, and the demand is expected to improve gradually, while the supply-side OPEC and Russia have not reached a new agreement on deepening production reduction, but the original agreement on production reduction has been extended, and the alliance for production reduction still maintains a cooperative relationship, the price of crude oil is expected to rise from the current overfall position to the cost support range. Brent crude oil price center is expected to recover to 55-65 U.S. dollars per barrel range.

Middle and lower combination:Demand is expected to deteriorate and supply is expected to maintain. If the global epidemic gets out of control, the global economy gradually changes from pessimistic expectation to reality, while the supply side OPEC and Russia do not reach a new production reduction agreement, only the existing production reduction agreement is maintained, and the production reduction alliance maintains a cooperative relationship, then crude oil prices may continue to fluctuate in the current overfall range, and there is room for further downward exploration. Brent crude oil price center may be located in the 45-50 US dollars / barrel range. In the long term, as US shale oil passively shrinks production at low prices, crude oil prices may rise back to the cost support range.

The following combination:Demand expectations deteriorate and supply expectations deteriorate. If the situation develops to the pessimistic scenario we expect, the global epidemic on the demand side gets out of control, and the pessimistic expectation of the global economy becomes a reality, while the supply-side OPEC+ production reduction alliance breaks substantially after the failure to reach an agreement, and the oil-producing countries increase production by vicious competition, then the supply-side pressure of the crude oil market will be close to the 2014-2016 level, and the demand-side pressure will be close to the 2008 level. Under the dual pressure, crude oil prices may reach the previous low.

Fourth, if it is not broken, the relationship between supply and demand in the crude oil market is expected to be fundamentally improved after the sharp drop in oil prices.

The growth of shale oil is sluggish and US shale oil and gas mergers and acquisitions are active. As the growth momentum of shale oil weakens, M & An activity in the unconventional oil and gas sector in the US has been active since 2018. In 2016 and 2017, the total value of unconventional oil and gas mergers and acquisitions in the United States was only 510-53 billion yuan, while that in 2018 and 2019 rose to 681-69.6 billion yuan, an increase of more than 33 per cent. Slower production growth, lower capital spending and active M & An activity may be a sign of accelerated clearing of unconventional oil and gas supplies in the US. As mentioned in our 2020 crude oil market strategy outlook, if US shale oil and gas can complete supply-side restructuring and increase concentration, then the crude oil market may return to the competitive pattern of oligopoly. The crude oil price volatility caused by this round of supply-side shocks since 2014 may come to an end, and a new round of crude oil price cycle will begin.

The peak of supply shock in non-OPEC countries outside the United States will end. According to the statistics of IEA, the crude oil production of OPEC and other countries outside the United States will increase greatly in 2020, mainly from Brazil and Norway. The growth of non-OPEC oil production began to slow in 2021. Although 2020 is a big year for crude oil production growth in non-OPEC countries outside the United States, we believe that this is the last peak of capacity release left by the last round of high oil prices, and the last round of long-cycle crude production capacity release has basically come to an end since 2021. In the future, the supply release of the global crude oil market will continue to weaken.

Loose money and demand for subsidies will drive a new recovery. Demand-side crises are often accompanied by interest rate cuts and liquidity release by the central bank, and sufficient liquidity in the market lays the foundation for the rise in asset prices. From historical experience, in the environment of sufficient liquidity and weak US dollar, once there is an improvement on the demand side, the driving force of demand replenishment will lead to a rapid rise in asset prices. The process of rebound after the sharp fall in crude oil prices caused by several economic crises in history has been rapid and violent. If the sharp fall in crude oil prices can accelerate the focus of US shale oil supply, then demand recovery and sufficient liquidity are expected to drive a stronger recovery in crude oil prices.

5. What are the black swans in the crude oil market after the start of a new round of recovery?

Based on the current fundamental situation of the crude oil market, we believe that after the sharp decline brought about by the epidemic and the failure to reach an agreement on OPEC+ production reduction, crude oil prices will start a new recovery cycle, in which US shale oil will no longer constitute the core upward pressure on crude oil prices, and the supply-side margin will once again return to the hands of Middle Eastern oil producers with abundant spare capacity. However, in the new round of recovery we are looking forward to, there are some black swan events that may have a greater impact on crude oil prices in the future.

The spread of the epidemic in the Middle East has affected crude oil production and export. At present, the COVID-19 epidemic in Iran, an oil-producing country in the Middle East, is developing rapidly, and the number of newly confirmed cases continues to grow. At the same time, other countries in the Middle East have also reported confirmed cases one after another. Although crude oil production is not a labor-intensive industry, there is still a risk of being affected by the epidemic. If the epidemic spreads significantly in the Middle East, which in turn affects the crude oil production and export of major oil-producing countries, it will have a greater impact on the supply side.

The geopolitical situation in the Middle East deteriorated. In 2020 and beyond, the control of the global marginal supply of crude oil will return to the oil-producing countries in the Middle East, and the geographical situation in the Middle East will bring greater influence to the global crude oil market. Considering the geo-events in the Middle East in 2019 and their short-term impact, we believe that on the one hand, the geo-risk premium in the Middle East will rise in 2020, and at the same time, we need to guard against the upside risks caused by extreme geo-events. on the other hand, once geo-events occur, the impact will last longer than 2019.

Sanctions on Iran and Venezuela lifted, crude oil production and exports resumed. Crude oil production and exports from Iran and Venezuela, which are also affected by their own economic problems, have fallen sharply as a result of US sanctions. Iranian crude oil production has fallen from a high of 3.83 million b / d to 2.09 million b / d, a drop of 1.74 million b / d. Venezuelan crude oil production has fallen from a high of 2.3 million b / d to 733000 b / d, a decline of 1.567 million b / d, a combined drop of 3.3 million b / d. If the United States removes sanctions on the two countries in the future and Venezuela recovers from the economic downturn, the recovery of crude oil supplies from the two countries will greatly affect the global crude oil supply.

The internal dispute in Libya has ended and crude oil production and exports have resumed. As of Feb. 25, Libyan crude oil production fell to 120600 barrels per day, a sharp drop of 1 million barrels per day from about 1.3 million barrels per day, according to the Libyan National Oil Company. The unexpected decline in production in Libya has played a greater role in alleviating the current supply-side pressure. However, in view of the past civil strife in Libya, it cannot be ruled out that the internal dispute in Libya will be settled in stages at some point in the future, when Libyan crude oil production will return to normal within a few months, bringing an increase of 1 million barrels per day to the international crude oil market.