It does not make a difference whether Russia cooperates with Saudi Arabia to control global oil prices because such cooperation would not impact the price of oil much given the weakness of the Organization of the Petroleum Exporting Countries (OPEC). Russia does not believe that it shot itself in the foot by abandoning a deal with OPEC to cut oil production. Russia’s oil alliance with Saudi Arabia and OPEC is masochism. Russia will decide whether to cooperate with OPEC in the future, but under its own terms and conditions.
Such views held by Russian energy analysts, economists, and Russia’s own state-controlled oil company Rosneft were prevalent leading up to a March 5 meeting between Saudi Arabia-led OPEC and Russia that resulted in a breakup of a three-year-old alliance aimed at collectively controlling global oil output.
Russia and Saudi Arabia are flooding the global market with oil at a time when demand has hit bottom and prices have collapsed due to COVID-19 becoming a pandemic.
Now, at loggerheads over the production cuts, Russia and Saudi Arabia are flooding the global market with oil at a time when demand has hit bottom and prices have collapsed due to COVID-19 becoming a pandemic.
The OPEC-Russian alliance was never built on solid grounds. Russian energy observers, even officials, openly grumbled that it was a burden on their country.
In recent months, Russia repeatedly violated its agreement with OPEC to cut production and it increased its own output. A dispute over Saudi Arabia’s decision to postpone an OPEC meeting planned for last June in Vienna to accommodate the busy schedule of Russian Energy Minister Alexander Novak galvanized complaints from many member-countries about Russia’s outsized influence in the cartel without being its member.
On the other hand, Moscow’s decision to reject the cartel’s latest proposal to cut production by an additional 1 million barrels of oil was based on its understanding that OPEC has in fact become too dominant over Russia’s decision-making power on oil matters at the expense of its national interests. It no longer wants to cede its oil market share to American shale oil producers, which now compete with Saudi Arabia and Russia neck and neck. The U.S. displaced them both as the world’s number one oil producer.
Russia no longer wants to cede its oil market share to American shale oil producers, which now compete with Saudi Arabia and Russia neck and neck.
The Kremlin has another ax to grind with the U.S. over its sanctions on Rosneft for cooperating with Venezuela and on Russia’s Nord Stream 2 natural gas pipeline project that planned to deliver gas to Europe. Now, Russia and Saudi Arabia are flooding the market with cheap oil to put U.S. oil producers out of business, replaying the oil price war of 2014-2016.
It seems that neither Saudi Arabia nor Russia have learned the lesson from the previous price war.
Before the onset of the 2014 oil overproduction and price crash, Saudi Arabia was confident of its chances to beat the U.S. shale oil industry while sitting on top of $737 billion USD in foreign currency reserves. Russia had $460 billion USD in foreign currency reserves in mid-2014.
After the two-year price war, both Saudi Arabia and Russia suffered major losses. Saudi Arabia went from a budget surplus to a deficit. Similarly, Russia’s budget suffered from a double-whammy of low oil prices and Western sanctions after it illegally annexed Crimea in 2014.
Saudi and Russian economies could not sustain the losses anymore when oil prices hit below $40 USD per barrel in 2016. They reconciled their differences and joined forces to coordinate oil production cuts since then.
But most importantly, the U.S. shale oil industry – the main target of their price war – did not go out of business.
Although dozens of American oil companies went bankrupt and hundreds of oil workers lost jobs, the shale oil industry came out more efficient and resilient than before the price war. The break-even cost – i.e. when cost is equal to revenue – of oil production in some areas of the Permian (in the southwestern part of the U.S.) and Bakken (in Montana and North Dakota) oilfields fell to $30 USD per barrel in 2016, attesting to improved shale oil drilling technology and lower production costs.
That means American oil producers reached a point where they could outcompete Russia and Saudi Arabia since the break-even prices of these countries are $45 USD per barrel and $83 USD per barrel, respectively.
Although the U.S. is the world’s largest oil producer, oil revenue is not a main source of the American budget revenue, unlike those of Saudi Arabia (70 percent) and Russia (52 percent). The U.S. oil industry is the realm of the private sector, while the Saudi and Russian states govern their petroleum industries.
Dependence on a commodity as a main source of national income makes Saudi Arabia and Russia vulnerable to price swings.
Dependence on a commodity as a main source of national income makes Saudi Arabia and Russia vulnerable to price swings. Although both countries currently have foreign currency reserves of more than $500 billion USD, they risk the stability of their economies if the oil price war drags on for too long.
Saudi Arabia and Russia are trying to drive U.S. shale oil producers out from the global market again. Undoubtedly, the U.S. oil sector will suffer losses from a combination of collapsed oil demand and prices due to the global spread of COVID-19 and oversupply of oil.
Many American energy companies will go bankrupt and thousands of oil workers are likely to be laid off. But the industry, which proved to be nimble, efficient, and profitable during the last price war, will survive the current crisis.
The bigger worry is the economies of Saudi Arabia and Russia since both depend on oil prices higher than the current $30 USD per barrel to balance their national budgets and advance their objectives.
Continuing to flood the market with oil when countries are on lockdown due to the COVID-19 pandemic, with no certainty when economic activity will resume, is suicidal for the oil-dependent economies of Saudi Arabia and Russia.
Continuing to flood the market with oil when entire countries are on lockdown due to the coronavirus pandemic, with no certainty when any form of economic activity will resume, is suicidal for the oil-dependent economies of Saudi Arabia and Russia, not to mention smaller OPEC producers with massive budget deficits such as Bahrain and Oman.
As both Saudi Arabia and Russia appear to be determined to continue their game of chicken, Saudi Crown Prince Mohammed bin Salman’s (MbS) goal to implement his ambitious Vision 2030, which would diversify the Saudi economy, reduce dependence on oil, and build the country’s public sector services, such as healthcare, education, tourism, and infrastructure, will be impossible.
MbS needs much higher oil prices to not just shore up enough money to push through any large-scale reforms, but also to keep his economy from crashing. Russia also needs to spend more to improve declining living standards and build major infrastructure projects, especially since President Vladimir Putin is seeking to extend his term.
After the OPEC-Russia talks, oil production cuts failed on March 5, Russian Energy Minister Alexander Novak told a Russian news channel on March 10 that oil prices would be restored in a few months.
An anonymous Saudi official told the Financial Times on March 16: “The beauty of this [oil price war] is you can blame it on the Russians. You have a legitimate answer, ‘Go talk to Vladimir, he’s the one who started this.’”
It may take time for Russia and Saudi Arabia to overcome their differences. But betting that the demand will recover soon and waiting for the opponent to blink on oversupply, while COVID-19 brings the entire world economy to a standstill for months to come, is a game that could harm the two countries more than any others.
