The oil price war between Saudi Arabia and Russia – sparked after the outbreak of the coronavirus pandemic – may push the whole world into a deep recession, with no winners in sight.
The price of the commodity has slumped, falling well over 50 percent this month alone, as a result of the toxic combination of the coronavirus pandemic and the oil price war between the Organization of Petroleum Exporting Countries (OPEC) and its allies—as they could not agree on further production cuts.
For over three years, President Vladimir Putin had kept Russia inside the OPEC+[i] partnership, allying with Saudi Arabia and the other members of OPEC to curb oil production and support prices.
The Russian-Saudi honeymoon was over in March when Russia told Saudi Arabia it will no longer comply with oil cuts.
But the Russian-Saudi honeymoon was over in early March after the Vienna meeting, when Alexander Novak, Russian Minister of Energy, told Saudi Arabian counterpart Prince Abdulaziz bin Salman that Russia will no longer comply with oil cuts.
Many observers have wondered what the logic was behind the Russian decision to leave the OPEC pact and whether Russia decided to sacrifice OPEC+ to stop US shale producers and punish the US for directly interfering in Russian energy deals such as Nord Stream 2—a gas pipeline running from Russia to Europe across the Baltic Sea.
But even the US has been applying pressure on Russia’s energy deals abroad—Chris Weafer, Chief Executive Officer and General Director of Macro-Advisory, thinks that Nord Stream 2 does not play any role in the latest Kremlin decision, as this project will be completed sooner or later. In any event, the existing US sanctions against Nord Stream 2 would only delay the project and add some additional costs. After all, Russia has always been very careful of its energy relationship with Europe and Germany in particular. Weafer explained that both have scrupulously avoided ever using energy as any sort of political leverage, despite regular statements by US Senators.
Weafer also does not believe that the Russian move was specifically aimed at creating a price war in order to target the US shale producers. “I think what happened in Vienna was a miscalculation or a misunderstanding of Saudi’s position,” he told Inside Arabia.
The OPEC+ policy of oil production cuts has deprived its members of important oil revenues.
Nevertheless, OPEC+ policy of oil production cuts has deprived its members of important oil revenues, even as the cuts were also a gift to the US shale producers, which flourished and greatly benefited with higher prices they didn’t help create.
Weafer explained that Rosneft (a Russian integrated energy company headquartered in Moscow) had been pushing a “no-deal extension” mantra in Moscow ahead of the OPEC+ meeting and one of the reasons was the recent US sanctions against Rosneft Trading SA, a Swiss-based trading unit of Rosneft that the US accused of helping Venezuela sell oil.
Also, it’s important to recall that Rosneft’s powerful CEO, Igor Sechin, has been under US SDN[ii] sanctions related to borrowing limits. “So, it is fair to say that Mr. Sechin has no incentive to do the US industry any favors,” Weafer added.
However, Professor Paul Stevens, Distinguished Fellow at the London-based Royal Institute of International Affairs, warned that imposing a war on the US shale producers would be very dangerous since the Russian economy is far more vulnerable to lower oil prices than US shale producers. Even though many smaller drillers look vulnerable and may go bankrupt, the largest American oil companies – Exxon Mobil and Chevron, control many shale wells and have the balance sheets to withstand lower prices.
Imposing a war on the US shale producers would be dangerous since the Russian economy is more vulnerable to lower oil prices than the US.
Stevens also insisted that the industry has a long record of being able to cut costs even further when faced with lower prices.
“Russia’s response and refusal to support OPEC+ could simply be a mistake on their part [while] it is also possible the Russians simply did not believe the Saudis would declare a price war as it has now done,” Stevens told Inside Arabia.
Soon after the Russian decision, Saudi Aramco said that it would increase oil production to 12.3 million barrels per day (mb/d) in April, flooding the oversupplied market with millions of new barrels. It seems that the Saudis have raised the stakes in an ongoing price war as their energy minister Prince Abdulaziz bin Salman played down the possibility of meeting with Russia anytime soon.
So, the question remains who will blink first?
According to Weafer, Russia – based on public information – is much better prepared than Saudi Arabia. Russia’s financial reserves (in February) were valued at $570 billion USD and have been increasing to $100 billion USD since early 2019. Russia also has a fully free-floating currency which means it is better able to manage a lower oil price environment.
Since Russian oil export revenues are denominated in dollars, but the Russian oil industry’s cost basis is in rubles, the depreciation of the ruble that recently took place means the companies will be at least partly protected, Mark Finley, an expert in energy and global oil at the Baker Institute, told Inside Arabia.
Russia needs an oil price of roughly $40 USD a barrel to balance its budget, while Saudi Arabia needs over $80 USD a barrel to balance its books.
According to the International Monetary Fund, Russia needs an oil price of roughly $40 USD a barrel to balance its budget, while Saudi Arabia needs over $80 USD a barrel to balance its books. Despite Russian production costs being much higher than the Saudi’s, the Kingdom’s economy is more dependent on revenues from oil sales. And with Saudi Arabia’s riyal pegged to the US dollar it cannot offset the lower tax receipts with the currency adjustment.
Weafer warned that the Saudis will soon have to start reducing planned spending in order to avoid depleting financial reserves too fast. Saudi Arabia’s reserves have fallen from over $700 billion USD (at the end of 2014) to under $500 billion USD at the end January 2020.
But while Russia appears now to be locked in a battle for market share with Saudi Arabia, the greatest casualties are almost certainly the US oil producers, regardless of their proven resilience. Most of them need oil prices above $50 USD a barrel to remain profitable, so ironically, they can only hope that their OPEC rivals return to speaking terms and stabilize the market.
With the coronavirus having an impact on the global economy and millions of barrels of oil flooding the market, both sides will have to put aside their differences.
Nevertheless, with the coronavirus having an ever-greater impact on the global economy and with millions of barrels of oil flooding the market, both sides will have to put aside their differences and act swiftly; although it is almost inevitable that the world will see a repeat of the 2014 oil price slump.
“We are seeing both a supply and a demand shock, and that is both an unusual and dangerous combination,” according to Weafer. “So, it is a reasonable assumption to make that demand will fall in western economies in Q2 and with so much additional oil coming from Saudi Arabia, we may well see mid to low $20s per barrel for Brent in the next month or two.”
While no one at the moment can make an accurate forecast, Finley pointed out some of the key questions that will determine the future developments:
1) How long does the coronavirus impact affect oil demand, and how big is the impact?
2) How quickly can US shale producers cut investment spending and partly offset it with large productivity gains as they did in the last downturn?
3) Can OPEC and Russia revive their production-cut agreement?
A prolonged war of attrition would be damaging for all sides forcing them to make difficult adjustments to their economies.
A prolonged war of attrition would be damaging for all sides forcing them to make difficult adjustments to their economies. To make matters worse, even if there were another round of OPEC+ cuts, and Saudi Arabia and Russia reached a settlement, the oil market is in deep and lasting trouble.
[ii] SDN are “Specially Designated Nationals,” whom the US targets with a travel ban and asset freeze.