Crude wars

The downturn in the global economy precipitated by the coronavirus is made worse as Saudi Arabia and Russia fall out over crude oil production levels and engage in a price war resulting in a free fall of fuel prices.

At an oilfield near Almetyevsk, Tatarstan, Russia, on March 11. Saudi Aramco’s plans to boost its oil output raises the stakes in a price and supply war with Russia and U.S. shale producers.

GLOBAL oil prices have plunged after the bitter parting of ways between Saudi Arabia and Russia. After a meeting in Vienna in the first week of March, attended by the oil Ministers of the Organisation of the Petroleum Exporting Countries (OPEC) and Russia, the unity that was on show for many years crumbled dramatically. Russia opposed the Saudi proposal to cut oil output further in order to stabilise global prices after the coronavirus pandemic adversely impacted global demand. The Saudi demand for a cut in oil production by 1.5 million barrels a day, amounting to 1.5 per cent of world supply, was rejected by Russia. Russia said it favoured continuing with the current production levels agreed upon with OPEC until the middle of the year.

Saudi Arabia reacted with anger, and Crown Prince, Mohammed bin Salman, the de facto ruler of the kingdom, ordered the ramping up of production and a cut in the price of Saudi crude by 10 per cent. It was the biggest cut in two decades. The Saudis are hoping to cut into Russia’s market share. By drastically cutting prices, Saudi Arabia is hoping to teach Russia a lesson for not toeing the Saudi line on production caps. Asian countries importing Saudi oil were offered a special discount.

The Russians have followed suit in a tit-for-tat move by upping their own production. The result was that by the second week of March, global oil prices had plunged by 25 per cent. It was the fastest decline recorded since 1991. The CEO of Saudi Aramco, Amin Nasser, announced in mid March that his company would further deluge the market in the month of April. He said that production would be set at “300,000 barrels a day over the company’s sustained capacity of 12 million bpd [barrels per day]”. Saudi Aramco is the world’s single biggest exporter of oil. According to experts, Saudi Arabia has started “a price war” against Russia, promising to sell its oil at a discount in order to maximise its own revenues.

The turmoil in the oil industry coincided with the downturn in the global economy precipitated by the coronavirus pandemic. The demand for jet fuel, petrol and diesel drastically declined while the energy market is facing a supply-and-demand crisis. The stock markets around the world were already plunging when the three-year-old alliance between the Saudis and the Russians fell apart. Saudi Aramco’s shares—the company had recently gone public—was one of the most affected. They fell by 9 per cent after Russia ended its agreement with OPEC. The authorities in Russia are confident that they will be able to outlast the low oil prices as they will be able to produce oil at the lowest cost, at around $20 per barrel. The Saudis too can produce oil cheaply but will have to sell it around $75 a barrel if they have to balance the national budget.

A prolonged oil-price collapse is beneficial to energy-dependent countries such as India, China and Japan. It is, however, not good news for the United States’ oil industry, which has become overly dependent on oil extracted from tar sands and fracking. The U.S. recently became the largest oil producer in the world, overtaking Saudi Arabia and Russia. But with the price of oil remaining low for the last seven years, many small oil companies in the U.S. have either closed down or gone bankrupt. According to oil industry analysts, for small shale oil companies in the U.S. to remain profitable, oil prices should be at least $50 a barrel.

One of the key reasons why Saudi Arabia decided to join hands with Russia was to keep the U.S. oil companies from undercutting them. The U.S. has become a big exporter of oil since 2014, cornering markets in countries such as India that until recently depended mainly on oil and gas imports from West Asia. In just seven years, U.S. shale production jumped from 0.4 million bpd to 4 million bpd. The last time OPEC had allowed oil prices to fall was in 2014, increasing production to offset the threat posed by rising sales of shale oil producers from the U.S. The price of oil had crashed to $30 a barrel that year.

Russia joined with OPEC in 2016 to stabilise the price of crude. The two sides coordinated in setting up production quotas until their break-up in the first week of March. Russia was convinced that the Saudi proposal of enforcing further cuts in production at this juncture would only benefit U.S. shale oil producers. Russia has now decided to take the U.S. shale industry head-on. A cold and calculated decision was taken by Russia to sacrifice the budding friendship with the Saudi monarchy. “The Kremlin has decided to sacrifice OPEC+ to stop U.S. shale producers and punish the U.S. for messing with Nord Stream 11,” said Alexander Dynkin, the head of the Russian think tank the Institute of World Economy and International Relations (OPEC+ is an acronym for the short-lived alliance between the oil cartel and big exporting nations like Russia). Stocks in small- and medium-size U.S. shale companies are already in free fall.

The U.S. had earlier imposed sanctions on companies involved in Nord Stream 11, which supplies gas to Germany and the Russian oil giant, Rosneft. The U.S. government had imposed sanctions on the state-owned Russian oil company for marketing oil from Venezuela. German Chancellor Angela Merkel strongly criticised the U.S. move on the Russian pipeline and urged the U.S. to desist from interfering in the internal affairs of European countries.

Oil prices to remain low

The price of oil in the second week of March was about $34 a barrel. Most oil industry experts predict that oil prices will remain low for the foreseeable future as there was a glut in the oil market. The low revenues from oil will also be detrimental to the economies of even the rich OPEC members like Saudi Arabia. For the Saudis to sustain their current level of governmental spending, oil revenues have to be at least $80 a barrel. After the Arab spring uprisings, the monarchies in the region had to dole out more subsidies to the populace to stave off unrest. Oil accounts for nearly 70 per cent of Saudi Arabia’s fiscal income. With their economies doomed to be dependent on oil for the foreseeable future, social unrest could be a distinct possibility if the price continues to remain low for a long period. Russia has $150 billion in reserves to cover a budget deficit for up to 10 years even if oil sinks to $25 a barrel. Oil and gas provides 40 per cent of Russia’s fiscal income.

The Saudi-Russian break-up also occurred at a time when the fissures within the Saudi royal family were becoming more and more visible. Recent events have cast a shadow on the privatisation of Saudi Aramco and the ambitious Vision 2030 programme. Saudi Aramco announced in the third week of March a 20.1 per cent drop in the profits for 2019. The world’s most valuable firm also announced that it was slashing expenditure for this year. The oil spat with Russia and the coronavirus pandemic have already had an impact on the Saudi economy.

At least four senior members of the ruling royal family have been put under arrest. They include Prince Ahmed bin Abdulaziz, the brother of King Salman, on charges of plotting a coup. The others are his son, Prince Nayef bin Ahmed bin Abdulaziz, the head of the Land Forces Intelligence and Security Authority; the former Crown Prince, Muhammad bin Nayef; and his half-brother, Nawaf bin Nayef. Prince Ahmed bin Abdulaziz is a direct descendant of the founder of the Saudi kingdom, Ibn Saud. He has openly criticised the present government’s policies, especially those relating to Yemen and its immediate neighbourhood.

The head of the International Energy Agency (IEA), Fatih Birol, meanwhile, warned that the Saudi-Russia oil price war could put at risk the ongoing fight against the coronavirus pandemic. “The world is facing a major challenge in fighting against the coronavirus,” Birol told the Financial Times . “I find it at best irresponsible that they are having a price war now. The people of the world will not forget who was on the side of fighting the virus, and which countries were on the side of making the fight more difficult.” Birol said that oil-dependent economies such as those of Nigeria, Algeria and Iraq would face large budget shortfalls as a result of the ongoing price war. The situation of oil-exporting countries like Venezuela and Iran, already reeling under U.S. sanctions, is even more dire. The IEA chief also warned that it would be a mistake to write “the obituary” of the shale oil industry in the U.S.

The Trump administration is unhappy with both its ally Saudi Arabia and its strategic rival Russia for triggering the oil price war. It has not only had an adverse effect on the oil industry in Texas, a State Donald Trump has to win if he has to retain his presidency, but also on the U.S. stock market. The country has witnessed the sharpest drop in its equity market since 2008. Trump’s supporters in the Congress are openly urging him to apply pressure on the Saudi Crown Prince into reversing his decision on oil prices.

Texas Senator John Cornyn, speaking on behalf of the shale oil lobby, suggested that Trump urgently speak to the Saudi Crown Prince and remind him of Saudi Arabia’s dependence on the U.S. for its security.