On March 6, negotiations between Saudi Arabia and Russia failed, and Russia rejected Saudi Arabia's proposal to reduce production. On March 7, Saudi Arabia ’s crude oil prices dropped sharply, starting a “price war”. On March 18, U.S. crude oil prices fell to a minimum of $ 20.52 per barrel, the lowest level in 18 years. Brent crude fell to a minimum of $ 24.52 per barrel, the lowest level since 2003.

When I worked in an oil company before, I also experienced a sharp drop in oil prices, which was a sharp fluctuation in oil prices from 2014 to 2016. At that time, the company's response was to improve quality and efficiency. Seeing the drop in oil prices this time, I was still thinking that we would start to improve quality and efficiency.

At that time, because I was in it, I didn't pay special attention to the rise and fall of oil prices. Like many fundamental investors today, once they identify a company's stock, they don't care about external shocks. Now I left the original company. Because of my current job, I am more concerned about the logic of oil prices.

In fact, in the 21st century, there are four cycles of relatively large fluctuations in oil prices. They are: from 2001 to 2002, the fluctuations caused by the burst of the Internet bubble and the global economic slowdown. From 2008 to 2009, the fluctuations caused by the US subprime mortgage crisis. From 2014 to 2016, fluctuations caused by the US shale revolution and OPEC's non-reduction in production. Since the beginning of 2020, the volatility caused by the new crown pneumonia epidemic and the collapse of OPEC + negotiations.

Although there are various reasons for the rise and fall of oil prices, the most essential reason to ask is undoubtedly "supply" and "demand". Every time the oil price rises or falls, it is caused by these two reasons, whether this kind of oil price fluctuation is regulated by the market spontaneously or it is artificially actively intervening. Other logics are applied to the "supply" and "demand" of crude oil.

In other words, the logic of oil price fluctuations is "supply" and "demand". In other words, the logic of oil price rise and fall is "supply" and "demand", and other logic is proceeding around these two factors.

On the supply side,

First, proven reserves

In 2018, according to the BP World Energy Statistical Yearbook, as of the end of 2017, the world's proven oil reserves reached 1.6966 trillion barrels. According to the production level in 2017, this reserve can meet the world's output of 50.2 years.

However, the world ’s proven and recoverable oil reserves have always been a “mystery”. It was said for some time that oil was only available for XX years. After a period of time, new discoveries have been made, and the number of years available has also changed. Regarding the depletion or non-depletion of oil, the final supply of oil is also full of variables. The actual supply depends mainly on the technical level and economic extraction costs.

Second, economic output

Oil supply is showing both natural shrinkage and artificial shrinkage. Oil is a diminishing asset, which determines the natural contraction of oil supplies. The artificial reduction of oil is manifested in the formation of monopoly prices, such as production restriction agreements. The second is manifested in economic output, such as the exploitation of shale oil.

Oil development requires investment. And if the investment income ratio is not high or even the output is less than the input. If oil extraction is not economical, supply will decrease. The recoverable reserves are less than the proven reserves, which is caused by the uneconomical exploitation of many mineral deposits.

Third, geopolitics

The Middle East is called a powder keg. In addition to the intricate state and ethnic conflicts here, another reason is that there is a wealth of oil here, leading to the participation of major powers, making the conflicts in this region more complicated.

The regional situation affects the nerve of stable oil supply and affects the fluctuation of world oil prices. For example, the Middle East War, the Islamic Revolution, the Iran-Iraq War, and Iraq ’s invasion of Kuwait brought three oil crises.

Fourth, the production restriction agreement

Historically, the OPEC production reduction agreement has been a fairly effective means of actively intervening in the price of oil, and has led to the oil crisis in Western countries in the 1970s.

However, in recent years, with the gradual realization of energy independence in the United States and the diversification of oil and gas geopolitical games, it has become increasingly difficult for the interests of all parties to reach unity, resulting in frequent fluctuations in international oil prices. In the future, there will be less and less space for oil prices to be regulated by reducing production, and it will become more difficult. The failure of the Saudi-Russian negotiations and the contradictions within OPEC countries have made market share the target of competition.

On demand,

First, the world economy

Although the growth rate of the world economy is difficult to predict, the growth of the world economy is slow and tends to weaken. The growth of the world economy directly affects the demand for oil. In the future, the economic growth of various countries will slow down, and the demand for oil will also slow down. Overall, world oil demand and total energy demand are slowing.

Looking at the three time dimensions of long-term, medium-term and short-term, the demand of the world economy for oil has weakened in the long-term, presents a cycle in the medium-term, and has a short-term impact.

Second, energy reserves

Strategic oil reserves are one of the important methods to ensure energy security and resolve short-term oil supply shocks. When OPEC alternately implements the policies of “reducing production and guaranteeing prices” and “increasing production and suppressing prices”, strategic reserves can promote the economic and political stability of importing countries, and not be affected by the impact of artificial oil supply based on political or economic motivation.

However, on the whole, energy reserves may be able to alleviate the problem of insufficient oil demand to a certain extent in the short term, but ultimately the insufficient demand caused by the world economic downturn cannot be resolved.

Third, alternative energy

Oil faces a situation where there are traitors inside, such as shale gas, shale oil, and chasers outside, such as new energy. Especially in recent years, the substitution of electric vehicles for gasoline vehicles has affected people's confidence in the long-term trend of oil prices. Especially in recent years, the substitution of electric vehicles for gasoline vehicles has affected people's confidence in the long-term trend of oil prices.

Once there are major technological breakthroughs in the future, such as graphene technology, the status of petroleum as a power source will be significantly affected and prices will fluctuate significantly.

Fourth, the trend of the US dollar

Oil is priced in US dollars, which makes the trend of the US dollar highly correlated with oil prices and presents a significant negative correlation. Generally speaking, the dollar strengthens and oil prices fall; the dollar weakens and oil prices rise.

Because oil provides support for the "petroleum dollar" system, the stability of the "petroleum dollar" system will be greatly reduced if the economies of scale brought about by the oil commodity trade are lacking. The movement of the US dollar affects the price of oil, although sometimes it affects each other.

In addition, there are emergencies that have a greater impact on oil prices, which can affect both supply and demand.

For example, last year, Saudi Aramco was exploded by a drone attack, causing panic in the market and rising oil prices. Due to the impact of the new crown pneumonia epidemic on the world economy, oil prices have fallen sharply this year.

The above are a few logics of the rise and fall of oil prices. How do we view:

First, sometimes it is a single logic that affects oil prices, and sometimes it is a superposition of various logics. Nonetheless, each time a large fluctuation in oil prices has a logic that has the greatest weight, which affects "supply" or "demand" and eventually leads to price fluctuations. So just grab the main logic every time.

Taking the decline in oil prices as an example, the new crown pneumonia epidemic is the logic of the emergency, but this is not the core logic that caused the decline in oil prices. The most important logic is that a severe downturn in the world economy has led to possible deflation and insufficient oil demand.

Second, oil is a commodity, but because of its importance to industry, oil is called the blood of industry. In addition, oil is a diminishing asset, which makes oil not an ordinary commodity. Oil became a commodity closely linked to politics, geography, and wealth after gold, and it was inferior to it.

Oil prices remain high, presumably because they are more of an industrial necessity. However, with the decline of the relative position of oil, the trend of oil prices will converge with the changes of other commodity prices, which will soon be affected by debt growth, the age composition of the population and other factors.

Third, the price of oil has shown a cyclical trend. The first reason comes from the importance of oil to the industry, and the second reason comes from the fact that oil has become a gold-like safe-haven asset. Perhaps, with the decline of the relative position of oil, oil may be more similar to gold in the future, becoming a veritable "black gold".

However, oil prices may continue to show large fluctuations. However, the cyclical fluctuations in oil prices do not mean that the cyclical fluctuations of oil company stocks or upwards. Because the market looks more at growth and the future. Can the current oil company return to its former glory days, or have it become a giant in history like railways and steel? Nobody knows.

Fourth, compared with the previous price, the current price is already very low. But if there is a technological breakthrough or alternative energy in the future, it is difficult to say that the current price is very low. However, from the current point of view, although production costs in some countries are lower than current prices, no energy country can afford the current prices for a long time.

Although Russia says it has no fear of a price war, it can afford the price of oil to stay at $ 25 to $ 30 per barrel for 6 to 10 years. Moreover, the depreciation of the ruble will help Russian oil companies to reduce production costs. For example, in 1997, Russian oil companies recovered from the devaluation dividend. However, considering that Russia's economy is heavily dependent on oil revenue, the feasibility is still greatly reduced.

Saudi Arabia's oil extraction costs are very low, and this time it is an initiative price war. But considering that Saudi Arabia's welfare is also heavily dependent on oil revenues. As oil prices have fallen, Saudi Arabia has issued bonds multiple times to make up for the budget gap caused by lower oil prices. In early 2020, Saudi Arabia also issued bonds worth a total of $ 5 billion. It is also questionable whether Saudi Arabia can insist on current prices for a long time.

Author: Jin Yunmu

A Researcher of Hong Kong International New Economic Research Institute

Double masters of Peking University and People's Congress

During his studies, he studied and exchanged for one year at the Royal Institute of Technology in Sweden.

After graduation, he successively worked in energy central enterprises and real estate PE. He currently works in private equity.