The Russia-Saudi Arabia oil price war during the COVID-19 pandemic- Equiflux Capital Group

The COVID-19 pandemic has changed global crude oil markets. Restrictive orders to contain the novel coronavirus (SARS-CoV-2) have created sluggish demand for crude oil, and the resulting crude oil glut has caused high storage costs. This has led to a significant change in the term structure in futures markets from a general backwardation to a contango, with the annualized percentage cost-of-carry spiking to above 100%. This paper uses an event study approach to analyze how the Russia-Saudi Arabia price war influenced global crude oil markets. Three major crude oil markets–West Texas Intermediate (WTI), Brent, and Oman are considered in this study. The nearby, third-, sixth-, and twelfth-deferred futures returns are used with the “roll yield” excluded when rolling over futures contracts, which could stretch our analysis to a one-year-forward horizon and keep our returns are historically realized. We also investigate the impact of the negative crude oil prices triggered in both the WTI futures and spot markets on April 20, 2020. We use the one-period simple return to calculate the daily returns to overcome an issue of which the natural logarithmic function defines in positive real numbers. Meanwhile, we also apply the log-returns that remove the negative crude oil prices to compare with results that consider the negative prices.

The findings indicate that information leakage before the event dates plays an important role in the war. This suggests that market participants could perceive and assimilate new information in the markets, thus restraining the corresponding impacts that should have occurred within the oil price war. Furthermore, the outbreak and truce impacted the markets asymmetrically, and negative impacts generated from information leakage during the outbreak are more durable than the positive ones it generated during the truce. In addition, with regard to futures markets, the impact generated by the oil price war is negatively correlated with the futures time-to-maturity; that is, the nearby futures undergoes the largest impacts and the twelfth-deferred futures experiences the smallest ones. This could be attributed to the fact that the high storage cost and limited spare storage capacity (not only in Cushing) would most influence traders who hold positions of expiring futures contracts to deliver crude oil, and should matter less for backdated futures contracts, since they are not delivered immediately. The obtained results suggest that the negative crude oil prices do not affect global crude oil markets on average, but they substantially influence the WTI crude oil futures and spot markets soley in that the WTI futures contract restricts the physical crude oil in the pipelines and storage facilities in land, which causes a loss of flexibility compared with the Brent and Oman crude oil contracts, where shipping and floating storage are available. Additionally, traders’ inexperience with physical delivery could also trigger the panic that caused them to liquidate their positions.

The oil price war substantially shocked the energy sector, and some implications are notable. The shrinking demand could put significant pressure on some downstream enterprises, such as refineries. According to the EIA (2020a), in mid-April 2020, U.S. refinery runs fell to 12.8 million/bpd, 24% less than the same time the previous year. Moreover, the net profit loss of oil companies was also significant. For example, Royal Dutch Shell announced a record net profit loss of −$21.7 billion in 2020, which is the first time it had experienced a negative net profit (BBC, 2021). In addition, the recession in the oil sector may negatively influence the performance of U.S. refineries in stock markets and affect their ability to invest in the future as well. Indeed, the world’s major oil companies, such as Exxon Mobil and Royal Dutch Shell, have witnessed the sharpest decreases in stock prices for decades. For instance, Exxon Mobil’s stock price dropped by about 55.64% ($40) from January to March 2020, which is the largest price fall in its history. The huge depreciation has also resulted in dividend cuts for oil companies. Royal Dutch Shell cut its dividend for the first time since World War II, with a 46% plunge in first-quarter net income at the end of April 2020 (BBC, 2020c). Moreover, due to the containment measures of the pandemic and downward pressure on operations, job losses were inevitable during the pandemic. BP announced plans to cut 10,000 jobs in June 2020, and about 10% of Royal Dutch Shell employees lost their jobs (BBC, 2020a). However, the recession in the oil sector also motivated oil companies to adopt new technologies, such as artificial intelligence, to improve decision-making and reduces business risks, with the help of the huge volume of raw data they already possessed and the growth of data management (Koroteev and Tekic, 2021). It is worth noting that the pandemic has also impacted the U.S. shale oil industry. U.S. oil production capacities have almost doubled since 2012 due to the shale oil revolution, and this has challenged the world oil order that OPEC established. However, the cost of U.S. shale oil is generally higher than conventional crude oil, partly because of the relatively higher cost of hydraulic fracturing technology.10 Hence, the low crude oil price triggered by both the pandemic and the oil price war is a negative signal to some U.S. shale crude oil enterprises. Indeed, U.S. shale oil sectors have experienced an unviable period and required a breakeven price of between $50 and $55 per barrel – a level that seemed impossible for crude oil prices to rapidly reach during the pandemic (CNBC, 2020). However, not everyone is a loser in the price war; some big oil importers are likely, theoretically, to benefit from the oil price fall and, if possible, replenish their storage capacity (BBC, 2020d).

To conclude, we would like to state some limitations of this study and suggest directions for future research. First, we restricted our attention to global crude oil markets; however, the oil price war also affected other energy markets. Thus, it would be worthwhile to determine how the war influenced them and whether the nexus between crude oil and other energy products, such as natural gas, and heating oil, has changed. Future research might also analyze whether the war influenced energy firms in equity markets, because their performance in equity markets is related to their cash flows, which also influences their profitability. Second, partly because of the limits of our methodologies, we restricted our attention to how the oil price war affected the crude oil markets in our sample period, whereas some other factors may have also influenced the markets. Hence, it would valuable to examine whether or how other factors affected the markets. Third, future research related to negative prices, such as price comovement and volatility spillover inclusive of the negative price (e.g., Corbet et al., 2020), is warranted. These three directions will be pursued in our future research agenda.