Turbulence in Energy Markets

Turbulence in Energy Markets

Leonhard Foeger/Reuters
from Corporate Conference Calls

More on:

Oil and Petroleum Products

Geopolitics of Energy

Organization of the Petroleum Exporting Countries (OPEC)

Russia

Coronavirus

Public Health Threats and Pandemics

Panelists discuss the recent upheaval in oil markets, including potential geopolitical ramifications and prospects for a resolution.

Speakers

Neil Robert Brown

Managing Director, KKR Global Institute and KKR Infrastructure

Amy M. Jaffe

David M. Rubenstein Senior Fellow for Energy and the Environment and Director of the Program on Energy Security and Climate Change, Council on Foreign Relations

Presider

Kassia Yanosek

Partner, McKinsey & Company

YANOSEK: Hello and welcome. Thank you, everyone, for joining us for this Council on Foreign Relations conference call.

My name is Kassia Yanosek. I’m a partner at McKinsey & Company, and I’ll be presiding over this conversation with CFR’s Amy Myers Jaffe and KKR’s Neil Robert Brown. We are very pleased to have them with us to discuss the recent upheaval in the oil market.

Before we get started, I just would like to remind everyone that this call is on the record.

So now, before we get going, I’ll set the stage for our conversation today. I think that everyone who’s listening in would agree that these are extraordinary times for the world and unprecedented for the oil market. In past years, oil-price shocks have been caused either by too much supply or a shock to demand, very rarely by both. And the current situation is that black-swan scenario. Oil prices have fallen by 50 percent since the start of 2020 and currently they hover around $30 a barrel. This follows the collapse of talks between OPEC and non-OPEC producers, which we call OPEC+, which includes Russia. And this happened on March the 8th, which triggered a price war over a production cut brought on by the coronavirus pandemic.

Today we’ll discuss the geopolitical motivations for the price war and triggers for a resolution; what this means for oil supply and demand; and implications for the financial markets, for U.S. producers, and for policy responses.

So to start us off, Amy, I would like you to walk us through what happened in Vienna. Why did OPEC+ collapse? And what can we learn from history to guide us? For example, if we look to the Asian debt crisis and what happened there with the demand collapse and then additional supply from Venezuela and Russia in the 1997 to ’98 time frame, what’s different this time?

JAFFE: Well, let’s start from the more recent days. So OPEC had a pretty successful run, OPEC+. So that’s OPEC plus Russia and some of the other producers have had a very successful agreement where they were holding back production. Saudi Arabia made particularly large cuts and we were actually starting to see the oil market come into a better balance. We even had high prices for a little while over the geopolitical risk in the Middle East.

So what happens is we start to see this fall off in oil use in China because of COVID-19, and Saudi Arabia starting diplomacy to try to get an early emergency meeting together, and Russia dragged its feet. They finally get to their regular March meeting and they—Saudis go in and they’re sort of seeking a cut, a combination of cuts. The Saudis have made it clear before that they’re not willing to cut alone, that they want cooperation from all producers, including Russia. And they could not—OPEC itself was able to make an agreement on how much they would cut, but Russia made clear that it felt that the size of the problem was too large and it did not—wouldn’t be constructive to try to make a cut of the size that OPEC was discussing. And it turned into a somewhat acrimonious session, which then led to the Russian oil minister leaving the meeting, saying that all restraints are off and producers are free to do what they think best.

Now, I don’t think the Russians were expecting Saudi Arabia to then come back and say we’re increasing our sales and thereby cut oil prices by $6 to $8 a barrel to push their oil into the market, but that’s really where we are today. And that caused oil prices to fall very precipitously.

As Kassia mentioned, the closest thing we’ve seen to that was back in 1998 when we had the Asian financial crisis and demand in Asia fell suddenly, unexpectedly. And at that time there was sort of a dispute about market share between Venezuela, which was rapidly increasing its productive capacity, and Saudi Arabia. And Saudi Arabia refused to cut its production to make room for Venezuela in light of the falling demand, and therefore we had prices go down—of course, it was a lower price environment in those days—but prices went down into single digits. That pushed OPEC and non-OPEC to one of its first very successful cooperative agreements and brought prices back up.

So that is sort of the historical context that we find ourselves in today.

YANOSEK: And just a follow up: What do you think is different today? Do you think that we’re going to see a similar type of response, or are we in a different world?

JAFFE: Well, I do believe that Saudi Arabia, one of the reasons why it felt that pushing a lot of oil on the market could be successful is that there is this history that that kind of shock and awe of just sudden drop in prices can focus producers in on cooperation. I think the danger this time around is that you—normally when that happens you get a boost to economic growth. I mean, it’s sort of like a stimulus because a lot of countries use oil in their industrial sector. You’ve got a signal to consumers, American drivers and elsewhere, that they can use more and travel more because they’re having this stimulus on their pocketbook in terms of fuel costs.

But the problem is in many places, even though we’re starting to see a resurgence of normal activity in China, we’re having these rolling curtailments in Europe and now in the United States, and those kinds of policies that are meant to slow the spread of the disease mean that oil demand will not have a normal response. In other words, the lower the price goes, it’s not necessarily going to mean that people are going to travel more, drive more, or spend more. And that’s really, I think, the challenge that OPEC faces today.

YANOSEK: Yeah. Thanks.

And Neil, would love to hear from you, what do you think it’s going to—it’s going to take to get OPEC+ to come back to the table? And what do you think those triggers might be?

BROWN: Yeah, thanks, Kassia. And let me just also thank CFR for inviting me.

And Kassia and Amy, it’s always a pleasure to be with you. I remember working with you on energy geopolitics even before shale was a thing, which probably will betray our respective ages.

I am obliged, as some of our listeners may be familiar with, to just give a disclaimer that these are my views, not necessarily those of KKR.

Having said that, I think, you know, Amy has really articulated the situation quite well and the challenges that OPEC and all producers face. My expectation is for oil prices to drop further than where we are today as Saudi Arabia, UAE, and others ramp up production really beyond market expectations, that markets had largely discounted some of those promises. And that’s going to be over weeks and months.

But nonetheless, as you get to, Kassia, my base case is for an eventual return to an OPEC+ supply-restraint arrangement. That doesn’t necessarily mean massive price recovery for some of the reasons that Amy just mentioned, and we can—we can come back to that. It’s really about containing damage to prices that we’re seeing in the market.

You know, so thinking about how to get OPEC+ back together again, we need to keep in mind two dynamics that are critical to the current situation. The first is the current oil-price collapse reflects a rare confluence of both demand destruction and massive oversupply hitting at the same time. That’s new. That’s unique in this market. And the demand destruction started where coronavirus started, in China, and that’s the most important market for oil-demand growth in the world. You take China off the table and the entire market is going to respond. And now, of course, we’re seeing coronavirus impacts deepen in three of the four key demand markets globally, and that’s on top of what was already a weakening demand picture with economic slowdown. The unexpected breakdown in OPEC+ in Vienna also is magnifying what was an already-oversupplied market, right? So both on demand side and on the supply side you’re seeing more augmentation of trends that were already underway.

The second dynamic to keep in mind is that this is really a Russia-Saudi dispute. Yes, U.S. shale is in—is the elephant in the room. However, the core issue leading to the breakdown, as Amy articulated it, was the disconnect between Saudi Arabia’s strong advocacy of deepening OPEC+ cuts and Russia’s hesitation that OPEC+ could sustain a price war with oil demand falling rapidly and unpredictably due to coronavirus.

But Russia’s intransigence shouldn’t have been a surprise to anyone watching Moscow. Russia has been resistant to deepening OPEC cuts for many months. And opinion is split within the Kremlin on whether to cooperate at all, and it has been that way for some time. It also recoils at Saudi’s forcefulness in Vienna in the run-up to those discussions and the distaste for OPEC+ supporting U.S. shale now over several years.

No one also should have been surprised at Saudi’s response to this. It’s clearly signaled since the start of the OPEC+ arrangement in 2016 that it’s unwilling to unilaterally lose market share and be the sole swing supplier. Russian cooperation has been absolutely essential to having a broad coalition within OPEC, which is one of Saudi’s main considerations in its willingness to cut at all and also actually have disproportionate cuts over the last eighteen months or so.

But on that, Saudi and Russian interests do point to reconstituting an OPEC+ agreement. Saudi did not expect a failure in Vienna last week and feels forced into plan B, that plan B being to inflict maximum pain in the short term to bring Russia back to the negotiating table. Supply response elsewhere is a welcome secondary benefit, and we’re going to start to see that in the U.S., and we can turn to that. However, Saudi Arabia doesn’t want to be seen as declaring war on U.S. shale. That’s quite important.

Saudi Arabia prefers to reinstate the OPEC cuts. It’s been clear about that. It wants to put a floor under prices. And that’s underpinned by, really, its core interests: its high fiscal needs, with a breakeven over seventy-five billion—or, excuse me, seventy-five barrels or so; its—the fact that Aramco’s IPO suddenly made a set of domestic constituents sensitive to stock price, and it’s been seeing that stock price fall; and that Saudi’s concerns regarding U.S. shale growth, which have been real, have really been abating recently as the U.S. shale patch has slowed.

Russia also has very strong interest in coming back to the table. It probably has more room to maneuver in the near term than does Saudi Arabia, but it’s also likely to have underestimated Saudi’s response. It’s significantly in a stronger position than it was in 2015. It’s got—it has a more diversified economy and revenue base. It has replenished its sovereign wealth fund to probably greater than $130 billion or so. Its fiscal breakeven is about $30 lower than Saudi. And it has a flexible currency, so it just has more tools than Saudi Arabia.

However, on balance it still wants more cooperation. That’s where its interests lie. One of the big motivating factors that went into OPEC+ in the first place was to improve relations with Saudi Arabia and extend its influence in the region. It also needs higher prices to support the economy, which is still under numerous sanctions, which actually may increase. And President Putin needs to keep its oligarchs and citizens on his side as he works to extend his presidency with the constitutional changes proposed that we’ve seen moving over the last few weeks.

But the timing of OPEC+ coming back together is unpredictable. Remember that oil is existential for Russia and Saudi Arabia. That means that President Putin and Crown Prince Mohammed bin Salman are the ones that will need to make the call on when to change policy. Neither of those personalities have demonstrated a willingness to compromise quickly, and both are prepared to hunker down for a price war at least in the medium term if necessary.

So I know everybody wants identifiable triggers, very discrete numbers that we can point to and say, all right, if this happens, Saudi Arabia—Saudi Arabia and Russia will change course. But you know, the reality is that because neither of them expected to be here, you know, the policy plane here is being built while in flight. So I think rather than clear triggers, probably what we need to watch are a constellation of factors, things that could really change their position.

The first and most important are signs of domestic unrest, whether that’s in the ruling elites or, less likely, among the citizenry.

Second would be signs of a bottoming out in coronavirus-led demand destruction. Russia was actually correct in the observation that OPEC+ was trying to solve a problem they couldn’t even define yet.

The third is supply response. Russians and Saudis will be encouraged by new CAPEX guidance coming out, just even some—just yesterday from Exxon, but will want to see actual physical reductions in supply, which should happen first in the U.S., given shale, that—given its capital intensity and steep decline curves.

And finally would be international pressure. That can play a limited role, I think not a tremendously large role. But the U.S. and G-20 pressure on Saudi Arabia could convince the kingdom to ease back on its rhetoric and, to some extent, ease back on supply. However, it’s unreasonable to think that Saudi or even OPEC will solve this all on their own. Russia needs to be at the table. And the reality is that the U.S. has very little pressure points on Russia.

But, you know, as I started with, and just to wrap up, you know, OPEC+ agreement will not solve weak oil prices. In these current market conditions, the best they can do is stop supply. We also have inventory building at records rate. That’s going to create an overhang that will take potentially years to get through. And then on the demand side, right, I mean, transportation is one of the most important uses of oil. And many economies have travel bans. Airlines are cutting flights in a very substantial way, slowing trade, slowing industrial activity. So in this situation low prices are not the cure for low prices in terms of oil demand in the near term.

And I think, thinking significantly longer term, we are perhaps getting a glimpse of the future of oil. OPEC+ is not a marriage, it’s an affair of convenience. At some point in the future, Saudi and its key partners in OPEC will once again shift to a market preservation mode. So we could be here, hopefully without the demand side, but on the supply side in another, you know, five, ten, fifteen years.

YANOSEK: Great. Well, Amy and Neil, you’ve really laid out the geopolitical context and also, you know, some of the economic factors. And that’s what I want to turn to next. I think everyone on the call is, you know, waiting with bated breath for your views of where short-term prices are going to go. And so I would like to just turn to the implications for supply and demand. You know, we can be—we’ve actually developed some supply-side scenarios that we’ve been sharing.

And, you know, they’re not too surprising in terms of what they look like. You know, one is more of a doom and gloom, where we don’t see an OPEC+ resolution and we see OPEC+ numbers increasing production for the next three years. And the goalposts are always moving, but in this scenario we saw oil in the 30s—we were projecting oil in the 30s to the 20s. And then there’s brighter scenarios as well, where OPEC+ goes back to the table and extends modest cuts, and maybe we see prices lift a little, above the 30s.

Now the challenge, of course, is demand. And I think that we all are, you know, unclear where the bottom really is. And to your point, Neil, you know, is the supply side enough? So you know, we’re certainly seeing even today Morgan Stanley cut their oil price forecast to $30 a barrel during Q2. They cut it from $35 a barrel. There are others that are more bearish in the market.

You know, Amy, I’d like to get your thoughts on what you think it will take for oil to distribute down before the end of the year. And even if we do see a resolution—an OPEC+ resolution—do you think it’s enough given what we’re seeing in demand disruption, and what’s your current view on that demand disruption?

JAFFE: So let’s start with signals. My view is that the Trump administration discussion of filling the strategic petroleum reserve is not about whether three or five or six hundred thousand barrels a day back into the strategic petroleum reserve is going to solve the problem, because obviously, as we’ve been discussing, we’re talking about a rather large instability of supply and demand. But it signals that President Trump is concerned about things that we should be concerned about—sovereign credit markets. We have allies, like Mexico and others, whose economies are highly affected by a very big disorderly fall in the price of oil.

So I think that the United States, if you think about it, by saying that we’re going to buy up some of our own shale production and put it in the strategic petroleum reserve, that’s kind of almost like a United States contribution to the stability of oil markets in a way that, you know, doesn’t interfere with free markets, and doesn’t interfere with OPEC dynamics. And it does signal, I think, to Saudi Arabia and Russia that the United States is focused on this issue, even with the president’s focus on consumers. I don’t think it contradicts that.

So I think the first question is, how concerned is Russia about the economic stability of Europe? How concerned is Russia about global credit markets, which they also—one would presume even with sanctions—there’s still some negative effects on their—on the recovery that they all need to get to their economy going at a clip. So I think that there’s geopolitical trends to work with vis-à-vis global pressure on producers to think about the stability of the financial system beyond just the, you know, sort of goals of an oil price war.

Now, that said, where are we going to go in demand? We’re already seeing some rebounding of industrial activity in China. We’re seeing in some Chinese cities people are moving back to work. So, you know, think of it like a rolling blackout. That’s a good thing, because that means that some market-stabilizing economic activity is going to take place. The problem is it comes in the context of these downturns in the West. And when you put together sort of pandemic worst-case scenario—hopefully we don’t come to that—the kind of oil demand loss we would see in that kind of scenario would be something of the order of magnitude of eight to ten million barrels a day from—models are estimating as high as twelve million barrels a day, depending on how much social distancing is required, and where.

So I do think that the demand loss is going to be substantial. And in thinking about the timeline for it to be restored, there aren’t a lot of good precedents to look at. I try to—not that this is analogous—but I try to remind people that after the attacks of September 11, 2001, it wasn’t really until 2004—end of 2004 where we saw global air travel back to its normal trajectory that one would have expected, had that event not happened. So I think it’s going to take some time for, you know, business as usual to normal. And that is going to make it difficult even if OPEC comes back to the table and we sort of move out of this crisis mode it’s going to take some while for things to move through the system and to have an economic recovery that would—where the recovery itself would stabilize the energy markets.

 YANOSEK: Great, thanks. So before we turn it over to questions, I just wanted to touch on, you know, one other topic, which is turning to U.S. soil and the state of U.S. producers. You know, I think we’ve all seen that, you know, many of these producers on average need prices in the 40s. That’s typically what we see in the shale patch. You know, our analysis shows, at McKinsey, that less than 15 percent of North America wells drilled last year would be economic at $35 a barrel. And we’re under that today. We’ve seen announcements that many of these folks have moved quickly to idle rigs, cut staff, and find other ways to generate cash for expenses. Exxon is the latest to announce plans to pick up spending. That was today. And further, you know, the industry is hobbled by weak balance sheets. We’ve seen bankruptcy deals faltered in the past couple of weeks since the market went into turmoil. And creditors are owed hundreds of millions of maturing debts by North American oil and gas companies over the coming years.

So given this context, you know, Neil and Amy, would love to get your responses—Neil, you can chime in first—on what you think the impact is going to be, both for the shale producers as well as the credit markets, and also your perspective on potential policy responses, as you’ve alluded to earlier.

BROWN: Well, producers are in cash preservation mode. We saw Occidental slash dividends. Exxon just announced big capex restraints. The smaller producers are all moving quickly to preserve liquidity. And the reality is, though, that this oil price plunge is hitting at a very difficult time. Price pressure, ESG considerations, competing technologies like electric vehicles on the horizon, and weakening political support were all weighing on the industry even before this current crisis with the coronavirus and the OPEC+ breakdown.

Most poignant, though, is—at least in the near term—is that capital was significantly more constrained going into this current situation. So for the oil patch this price drop is hitting at a very different time than the most recent price collapse in 2014-2016. Then prices dropped, but capital was readily available. Although U.S. production did drop during that time, I’d say that the U.S. was actually the big winner of that price war because it pushed the industry to be so much more efficient and competitive.

The crisis is hitting at a time of capital constraint this time. Shale is extremely capital-intensive due to high decline rates. So certain companies have to keep rolling cash into drilling, and more drilling, and more drilling. More investors—many investors have really grown tired of see all the cash flow plowed back into the ground rather than paying dividends. The peak of new public equity issuance was around $30 billion in 2016. That was down to just about a billion last year, before this crisis even happened. That spigot is effectively shut now. The high-yield bond market was already becoming harder to access before this crisis. To the limited extent that the market will be available in the short term, it will come at a very high cost both because of oil market crises and because many holders of that debt are probably feeling overexposed right now.

Those are both challenging dynamics, but the potential real concern from many players right now and over the next few months are a couple things. First, there was a big wave of refinancing around 2016. That five-to-seven year paper will start coming due in another eighteen months or so. So the duration of this downturn really does matter for the solvency of these companies. Second is the commercial bank lending market that companies use for working capital. Many of those banks are over-exposed and trying to pull back. And a number of them are regional banks that may face liquidity concerns themselves. Banks have the ability to reassess the value of their collateral, which is usually reserves in the ground, as frequently as every six months or so.

And that banking market is many times larger than the energy high-yield bond market. So this is a problem both for upstream companies and for the financial system that hopefully policymakers will start engaging on. But I do want to share a note of optimism. We do see, and there are really great opportunities for investors and companies in this market, in this environment, both in terms of public and private markets. The quality of U.S. reserves, the talents of our workers, expansiveness of the infrastructure, flexibility of our capital markets. All that means that the U.S. isn’t going anywhere as one of the top three global producers in the near future.

I know you also asked about policy responses, but maybe let me defer to Amy first, if she wants to add anything on the U.S. market response.

JAFFE: Well, I do think that, you know, there’s a long list of industries that the Treasury Department needs to look at in terms of credit and also just, you know, national health. So I do think that one could, as Neil was mentioning, as these problems roll forward, there is a concern about the credit markets and the influence of the energy high-yield bonds. That could be sort of a renewed concern. In 2014-2015 what happened with those bonds was also sort of a market indicator for instability across the financial markets, beyond energy. And there’s definitely a contagion effect between the high-yield bond market in general and the energy high-yield bond. And that spills over into the general corporate bond market. So I do think it’s something Treasury is focused on.

It’s possible we’ll see some kind of a TALF or term-lending securities facility over time that might be brought to bear into this sector to try to keep credit flowing in the broader market. So maybe energy has to—Treasury has to take some of this debt off the books of the banks and give them Treasurys in return in the hope that as oil prices stabilize over the run that markets will be calm and eventually Treasury will be able to make good, because the companies or the asset itself, as Neil mentioned, will be able to sort of come back online.

And this really raises this question about the appetite for different classes of investors, because this is going be now the second time that institutional investors who are very excited about U.S. energy back in the early 2010, you know, have had to, you know, put a handkerchief up to their forehead of sweat about the fate of some of these bondholders—some of these bonds and, you know, the underlying stock of some of these companies, especially the smaller firms. A lot of variation in the industry. You have some very effective hedges still in place for many companies. You’ve got other companies that put in hedging strategies that were not anticipating the market to go down this low. So there’s a lot of variation in company positions. Some companies are worse off than others.

And I think that makes it sort of a mixed bag. That’s why having Treasury really look at these term asset lending facilities, instead of doing some of a broader kind of tack or other kind of support, makes more sense because not every company needs support. And there are a lot of companies whose balance sheets are positioned to weather this. So I think, you know, that’s sort of the view moving forward. There are some investors out there, bit investors, big players, that people think of and try to invest alongside to strategically, who have said: Low oil prices are going to provide an opportunity, the bottom fifth, a very interesting opportunity.

But then you’re going to have other investors who are focused on environmental and social trends. And they really feel like this is just a signal that, yet again, a reason not to be involved in the fossil fuel sector. So I think it’s going to be a mixed bag. And we’ll just—you know, it kind of depends on, you know, how it plays out and if we see, you know, some companies are doing well, they might turn out to be big winners because the capital that wants to go to this sector might go to these better-managed companies.

YANOSEK: Thanks, Amy.

BROWN: Amy, your—

YANOSEK: Oh, go ahead, Neil.

BROWN: Amy, your comments—oh, I’m sorry, Kassia, go ahead.

YANOSEK: No, I was—I was going to say, I’d love to turn it over to some Q&A. But, Neil, why don’t you give a kind of a thirty-second or a minute cap responding to Amy’s comments?

BROWN: Yeah. Amy, I think you make a lot of really good points on the policy response. And I—you know, it brings me back, you know, to the 2008 time period when I was working in the Senate and thinking about the response then. And just the general hypocrisy really of U.S. politics and the reaction of many companies towards OPEC, right, which is—again, we’re against OPEC when it does work in restraining its supply, and we’re against OPEC when it doesn’t work in restraining supply. And that, you know, to the least, sends very unclear messages to Riyadh. And that’s going to be a challenge that the administration needs to overcome when thinking about the foreign policy response.

Now, in terms of the domestic response, so the—you know, President Trump really celebrated low prices for consumers first, but I think the reality seems to be setting in, which is that the U.S. today is a much more complicated place when it comes to the oil industry. And there’s several—states that are going to be hurt by this downturn. States like New Mexico, Colorado, Pennsylvania, and even Texas, all of which could swing the election. So now this is becoming a big political issue.

You know, the Trump administration is using the authorities in its executive power to make some inroads. And the FTR filling makes a lot of sense. But, you know, I think we need to be honest here that a broader policy response really requires working with Democrats. And as a party, the Democratic base has shifted to a position that has hardened against oil and gas. Now, that isn’t to say that they want worker layoffs or reduced tax bases, but by definition they do want stranded reserves, which means shutting in fields. So this is a very difficult political issue. And we can talk about what might be able to get passed in terms of a broad coalition, but that’s the dynamic that policymakers are facing when trying to respond here.

YANOSEK: Well, thanks, Neil. I think we have covered a lot of ground in just thirty minutes, and I know we can just keep going with this conversation but wanted to turn it over now to the floor for questions. As a reminder, this call is on the record. So if, Operator, you could please give instructions for asking questions, and we can go from there.

OPERATOR: Thank you.

(Gives queuing instructions.)

We’ll take our first question from Brian Dabbs with the National Journal.

Q: Hey. Thank you so much for doing the call. I just really kind of wanted to home in on the diplomatic angle here. So we really—a week ago, I think to the day, so last Tuesday it was confirmed that Trump had—President Trump had spoken with Mohammed bin Salman. And we really haven’t seen, as far as I know, any substantive diplomatic pronouncements since then, and really even then there wasn’t much substance that was relayed in terms of kind of the content of the call.

So I’m just wondering what you all think about kind of the diplomatic handling of this. Obviously if the U.S. wanted to, you know, coerce, if you will, Saudi Arabia to readjust its strategy and scale back the buy, which, you know, raises prices, it has a lot of levers to do that. So I’m just kind of interested in that. I mean, obviously the diplomatic behavior is causing some concern on the Hill. There was a letter sent yesterday to the administration and to Saudi officials from Senate Republicans. You know, there’s pressing concern. So if you could speak to that, that’d be great. Thank you.

JAFFE: Yeah, let me—let me take that first. I want to call—especially for the media that is on the call—I want to call your attention because in the first day of this diplomatic event besides the president’s calls the secretary of Treasury visited with the Russian ambassador to the United States, and he put out a statement expressing the United States’ interest in orderly energy markets. And I think that it’s very complicated, the diplomacy, in the following way: As might have been mentioned earlier in the call Igor Sechin is a very influential person in Russian policymaking when it comes to oil. He absolutely has asserted his influence in the current weeks, leading into the OPEC meeting. And there was differences of opinion inside Russia, as you can imagine, about what their policy should be towards OPEC+. And Sechin’s attitude appears to have won the day.

Now, I refer everybody to Sechin’s speech of October before—in front of the Eurasian Forum, where he really adamantly attacked U.S. sanctions policy, saying that—and twisting it, and saying that somehow U.S. sanctions policy really didn’t have anything to do with any of the issues that the United States has said is a problem geopolitically, but rather is just a ploy to move oil out of the market by Iran, or Venezuela, or Russia, to make space for U.S. production.

So I believe that by the president signaling that the United States is going to help the market by thinking about the use of this strategic petroleum reserve, by having his secretary of treasury meet with the Russian ambassador, obviously Igor Sechin is looking for the sanctions against Rosneft, his company, their trading division that has been moving Venezuelan oil, he’s obviously interested in that. And that’s complicated, because that means the United States at a time when we’ve got bigger fish to fry would have to focus on an agreement with the Russians about how to move forward in Venezuela.

So it’s a very tricky diplomacy. And I think that the negotiation, in my opinion, is not really between the United States and Saudi Arabia. I think the negotiation is really between the United States and Russia. And I do believe there should be things to work with. The Russians have a deep interest in having the European economy stay on track, because their economy is so tied to Europe. And that’s one of the reasons why they weren’t willing to cut their production and cede Europe to other producers. And that is why Saudi Arabia, in showing the Russians that to come back to the table they made their largest price cut in their prices to Europe. And so I do think that where everybody’s concerned there is—you know, there’s common interests. But, you know, like has been mentioned, it’s very—it’s very hard. It’s not easy diplomacy. It’s complex diplomacy. And it’s going to take—it’s not something that’s going to happen in, you know, three phone calls.

YANOSEK: No. Thanks, Amy.

Next question.

OPERATOR: Thank you. We’ll take our next question from Tom McDonald with Partner—I’m sorry—with Vorys LLP.

Q: (Off mic)—to Africa. And obviously, it’s a huge supplier of oil to the world. And the question is, how will some of those, frankly fragile, economies, even a Nigeria, even an Angola, or a Gabon, handle, you know, this huge uncertainty and plummeting demand?

YANOSEK: Great. You were cutting out, but I think your question was how will fragile economies handle the current situation—

Q: How will—this is Tom McDonald—how will African countries handle—like a Nigeria, like an Angola, like a Gabon—handle, you know, where their natural resources are such a, you know, source of income? How will they handle the plummeting prices and demand?

YANOSEK: Yeah. Neil, do you want to take that?

BROWN: Yeah. I can give a few thoughts on that. The real answer, of course, is that the response will be different for every single country, because they face very different situations. You know, Angola was already in IMF discussions. Nigeria, you know, still has a dual exchange rate, you know, still reticent to devalue the naira, et cetera. So it will be case-by-case. I think, though, that there are two big factors that are hanging over this. I mean, one is that the United States and other countries have put a substantial amount of diplomatic effort behind measures that would help reduce dependence on oil and gas and other extractive mineral revenues. This situation shows how much work there is still to do.

You take a country like Angola, that has been fabulously rich on oil revenues by the headline numbers, and they—you know, the last time I was in Luanda, you drive a little bit off the esplanade and the—you know, the front windows of people’s homes are actually below the trash line of the road you’re driving on, right? So it’s massive misspending and lack of diversification. The second issue, and this is the kind of cruel irony of the current diplomatic breakdown that has led to this situation, which is the countries that have most influence—Saudi Arabia, Russia, the United States, you know, to some extent the UAE and a couple others that can maybe help guide the discussion—those are also the countries that have the most wherewithal to survive the current price downturn.

When you’re talking about the African countries, and you can add to that countries like Ecuador in Latin America, some Central Asian countries, these are the countries that have basically zero influence into that debate. They will be takers of whatever Saudi Arabia and Russia decide. And there’s very little that can be done on their part to change that dynamic. And so that’s why we have to focus our efforts very quickly on trying to get Russia and Saudi Arabia back to the table.

Q: Thank you.

OPERATOR: Thank you. We’ll take our next question from Erin David Miller with Carnegie.

Q: Terrific briefing, by the way, at CFR.

I have a question. One of the two of you, I think it may have been Neil, referred to domestic unrest, either assuming Russia or Saudi Arabia as a key factor and a key accelerant. That might move one or more parties toward a deal. Exactly what you do you mean, when you talk about domestic unrest in Russia and Saudi Arabia?

BROWN: Yeah. The—I think that there can be a tendency, you know, for energy market analysts to look just at the—you know, sort of do the barrel counting and do the price forecasting and say, well, that’s what’s going to drive the politics. And it does have some influence. You know, likewise, you know, the international relations or foreign policy experts to come with sort of big, esoteric theories of how things function. But put your mind—put yourselves in the minds of individual leaders. And that’s—whether it’s President Putin in Russia or Mohammed bin Salman in Saudi Arabia, even President Trump in the United States—their first thought is towards domestic impacts.

And what you—what you have seen is this crisis on oil prices is hitting at the same time as very big domestic changes. So President Putin trying to change the constitution in Russia to get himself two more terms, right? Another twelve years. So anybody who thought that he was going to go away should be disabused of that reaction. Mohammed bin Salman, concurrent with the Vienna breakdowns, arrested several senior princes, the people who should there be unrest, would be best positioned to replace him as crown prince. Are the two related? I don’t have enough connectivity in the intelligence services to be able to say so—(laughs)—but it certainly seems like a pretty big coincidence.

So I think what you’re—what you need to watch for is pressure from the people—in the case of Russia, the oligarchs who have a stake in this, who see their incomes—their business incomes, as well, dropping. Or citizens, who are going to be ultimately asked to take the pain, right? The fiscal break-evens take you so far in terms of how far can the countries last, but there will have to be—there will have to be pullbacks in social spending, in infrastructure spending, in the bureaucracy, you know, with the state being such big employers. So those are the kind of things that you have to be looking for.

YANOSEK: Thank you. Next question.

OPERATOR: Thank you. Thank you. Our next question from Amy Harder with Axios.

Q: Hello. Can you guys hear me? Thank you so much for holding this call. So I have two questions. First is, to what degree do you think the low—or the persistently low oil prices could lead to unrest in certain Middle Eastern countries? And then to what degree do you think that could breed terrorism, that could then, obviously, adversely impact the rest of the world? And then my second question, unrelated, is: How do you think this overall oil price collapse and the broader economic recessions likely from the coronavirus, how do you think that will impact efforts to address climate change? Thank you.

YANOSEK: Thanks. So, Amy, why don’t we talk about the implications for potential terrorism and terrorist activity? I think that is a new question that we haven’t addressed yet.

JAFFE: Well, I think the first thing one wants to look at is what were we already having in the trend line? So in Iraq, in other places in the Middle East, you had a lot of unhappy citizens who are already out on the streets, angry about corruption, angry about the lack of services. I do think that now we’re adding to that two new things, which is first, of course, the suffering of people in places where coronavirus is not going to be contained well. So that’s one big, huge problem in the Middle East. And so then that’s just a human suffering issue, where if I don’t have faith in my government in the first place, and now that were to somehow catapult into some national health crisis, you can just imagine the ramifications of that.

And then I think secondarily I do think that populations in places like Iraq, and across the Middle East, and especially in high population countries, even in Iran, people who are reading and educated about the trendline have got to be concerned. It was always said out in the Middle East that, you know, in ten years or twenty years all these other oil production would be shut in, in the North Sea or in Alaska, and we’re going to be in control, and everybody’s going to be coming to us for oil. And the sort of prospect of peak oil demand, and the prospect of climate policy, and also just the, you know, surge in new technologies—whether that’s electric cars, or 3-D printing, or, you know, different kinds of ways of manufacturing—all those things are going to start to make populations realize that the clock is ticking, and that the days when they could count on a renewed rise in the price of oil may be over.

If not, maybe the price of oil might go up for a year or two because of some kind of geopolitical event, but the long-term trajectory of thirty years or fifty years of high oil prices, which was previously expected, is off the table. And that is going to make it much more difficult on the ground in countries where the government has not been able to provide basic services to people.

BROWN: Yeah.

YANOSEK: Thanks, Amy.

BROWN: I think that’s a really good point, Amy. And you’re seeing real differentiation within the Middle East in terms of the ability to execute on the visions to diversity. Everybody has division. The question is, who’s actually implementing it? Abu Dhabi, for example, is making very good progress. But, you know, others have faced more challenges. I think on the climate angle to the question, just a couple quick thoughts. The current economic downturn in coronavirus is producing really significant challenges for the renewable power industry. We’re seeing supply chains cut. It’s very hard to build, to install, et cetera. But, you know, that’s really about the economic downturn and dislocations of trade, not so much about the oil price. If anything, the oil price drop probably is helping renewables, at least in the U.S. on the power side, because gas would tend to increase in prices conversely to oil.

On transportation, there’s been a lot of speculation out there. I think you’ve reported on it a little bit, Amy, about the impact on electric vehicles, et cetera. But, you know, the fact of the matter is that electric vehicles aren’t price competitive today. What’s selling electric vehicles are consumer sentiment and public policy. And so the question is, will those endure, even despite low gas—lower gas prices. I think that the two or three big questions for climate is, you know, we’re talking about a very extensive economic displacement, dislocation. We’re probably talking about a recession, perhaps on a global scale. Let’s see how the coronavirus plays out. Will governments still be as committed to transition—to energy transition, which is costly, in that scenario? I think we’re going to see a differentiation in regional responses.

I think a second big question is, are we seeing the future? So I put out a thesis that OPEC+ will most likely come back together. But that’s—as I said, that’s an affair, that’s not a marriage. Over the long term, the Middle East, the big players, Saudi Arabia, UAE, Kuwait, they’re all—they all have understood that over time there will be demand disruption. So they’re positioning themselves to keep producing through that. And they have the cheapest oil in the world, so they are. So they will be able to do that. So then the question is, you know, what will it take for alternatives to be able to actually compete with cheap oil in the future? And that’s where, I think, the advocates of alternatives need to really focus, on driving those costs down.

And then I think one related issue on foreign policy is, you know, there’s been a lot of focus recently on placing molecules, American molecules, around the world. The current situation is showing the limits of that, right? As you know, Amy, I’m a big advocate—have been for a long time—but we really should be advocating open markets for transparency, for competition, because that’s actually what’s going to serve our foreign policy interests over the long term, regardless of the exact number of barrels that the U.S. produces.

JAFFE: Thanks. You know, I would add one more thought to the question on climate change. You know, the one thing that we haven’t talked about is the role of industry and of companies in making the energy transition. And I think the current environment does throw into question what companies are able to do to invest in solutions for, you know, a low-carbon world. In mid-February the BP CEO announced a vision for net zero emissions by 2050. But to do that, he talked about how they need to perform while they transform. And so you know, the lack of dollars available to make that transition could make this harder. Occi has had a similar announcement recently with their low carbon ventures and their activities there. So I think, you know, there is a question about what is it going to take for companies to change their portfolios in this new world, and what does value creation look like for them going forward?

YANOSEK: Next question.

OPERATOR: Thank you. We’ll take our next question from Welby Leaman of Walmart.

Q: (Off mic)—for your good comments.

Looking at North America, what impact do you think this disruption will have on the politics of Canada and Mexico? And in particular, does Canada get more facilitative of pipelines because of this, or abandon the frackers and find some other way to stimulate the economies of the prairie? And in Mexico, if this—if oil prices blow a hole in AMLO’s budget and he can’t pay for his social spending without raising taxes and has trouble raising taxes because of the recession that’s likely to come, will he fix this tension through upstream liberalization?

BROWN: I can take a first stab at that. And, Welby, nice to—nice to hear from you. You know, Mexico—(laughs)—many books will be written about AMLO. He’s a very, very complicated character. But there are two outstanding traits that are going to come into tension here. First is that he is—he is what he claims to be, in terms of a populist nationalist on energy issues. He does not want foreign investment in the upstream. He’s been—that’s been his position for his entire political career. And I see very little reason to think that he’ll meaningfully change that position. Rather, what you’ll see probably is the increased emphasis on trying different versions of basically supply contracts, that did not go very well previously in the kind of 2008 and after period. But nonetheless, they’re going to try. But what you may see are—is an increased willingness to give private investment within midstream associated infrastructure, et cetera.

So second thing about AMLO is that he truly believes in austerity. He lives it in his own life. That’s real. And he believes it for the country. The good news is that Pemex is less responsible for—as a percentage of revenues—as it was just a few years ago. So that is positive. But that will bring forward the difficult decisions he’ll have, which is how does he keep a balanced budget given his social spending—his social spending demands. I think that he is unlikely to abandon fiscal discipline because he has really staked is reputation on it and understands that in Mexico’s open market he can’t really afford politically to let the peso get up to twenty-three to twenty-four for a sustained period. He understands those dynamics. And so we’ll find solutions, even if they’re short-term solutions.

YANOSEK: Thanks, Neil. Well, I think we’re about at time. So I first just wanted to thank my friends Amy and Neil for their insightful comments on a whole host of issues relating to the turbulence in oil markets, and also to all of those who are participating on today’s discussion. Thanks, and you all may disconnect.

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