7 April 2020, NIICE Commentary 3960
Abhishek Mohanty
The cases of COVID-19 increased in China, despite World Health Organisation’s argument that there were no imminent fears from it. The prediction failed, Chinese market collapsed, and their demands of oil also dropped. This led to an emergency meeting amongst the Organization of the Petroleum Exporting Countries (OPEC) and associates, where the de-facto leader Saudi Arabia asked Russia to lower down its oil production. Moscow denied to cooperate, and in return Riyadh waged oil price war. This article explores what could be the possible reasons of the oil price war, who really gained out of it, and what would be the future of oil market.
According to US think tank Atlantic Council, on 8th March 2020, an emergency meeting of OPEC members was held to discuss on evading the concerns arising from COVID-19 which led to significant reduction in oil demands, mainly because orders from China declined. The de-facto leader Saudi Arabia didn’t find it reasonable to continue higher production of oil due to lower demands, and asked Russia to cut down its oil production by around 500,000 barrels a day. Saudi Arabia and Russia are two of the top three global producers of oil, so it was natural that both had a major role in the meeting.
Russia, not being a formal member of the cartel, didn’t feel it was bound to abide and out rightly rejected the suggestions. Furthermore, Russia also announced to pull back from the OPEC+ agreement, which came into force in 2016 that allowed non-OPEC countries to cooperate with OPEC members. In response, Riyadh instigated its most inimical oil-linked measures in decades, and threatened to overflow the market with a surplus of 2.6 million barrels at extremely reduced rates. The announcement caused an intense fall in oil prices, with Brent crude oil dropping by 30 percent, recording the biggest drop since the 1991 Gulf War.
What led to the Oil Price War?
The differences between Russia and Saudi was visible since last year, and the collapse was not unexpected. Due to their differences, the experts from diverse fields are also divided over the genuine intentions of this situation. This has led to two different perspectives in the global intellectual community.
The first is that it was a long-time desire of Russia to keep prices down so as to create chaos in the American shale industry. The immediate consequences give the impression as if that was the true motive of the Kremlin. According to CNBC, the stocks of small to mid-size American shale firms went in free fall, with the valuation of some plummeting down to 45 percent, until Trump administration announced government backing. Unlike those countries, where big, state-backed corporations control the market, the American market is packed with smaller companies that are debt-ridden and have low profit margins. In the instance of no government backing, they tremendously rely on reasonable market rates to continue their existence.
Furthermore, leading business media Bloomberg and Financial Times have reported that the US shale market was partly the reason why Russia moved away from the OPEC proposal, since Russian President Vladimir Putin believed that backing efforts to have oil rates high will contribute benefits, only to Washington. This can possibly be a way of retaliation from Russia to the US for imposing sanctions on Rosneft, Russia’s largest oil company, due to its approval of several oil deals with Venezuela in February, where Trump administration is hell bent in ousting the socialist regime. Now, the Kremlin is developing a new strategy, where it no longer wants the cooperation of Saudi, rather it seeks to compete against them as well as the US.
The second and more considerable perspective is Russia’s intention to sway more power in the international oil market. It couldn’t have been possible by cooperating occasionally to expurgate production with Saudi. In any case, Russian corporations still cash benefits even if they export at a low rates for some time. The revenue margin will be less, but still it is possible for them to attract clients and generate significant profits. Russia has a flexible economic structure, which means when oil rates drop, taxes fall with them. However, analysts have rarely focused on the real intentions of Saudi. While it’s largely perceived that the Saudi launched drastic measures to rebuke Russia, but the unexpressed motive is the palpable target – the world’s leading oil producer, the US. According to Financial Times, over the past decade, the tremendous development of shale oil transformed the US from the label of world’s largest oil importer to a net exporter. During this period, American firms seized huge shares in the global market especially from Saudi Arabia.
Saudi Arabia was well-aware of the potential development of shale oil, and previously it had tried but failed to destroy the US market. During 2014-15, CNN reported that Riyadh plotted a crash in global oil rates that triggered economic downfall and bankruptcies in big and small American shale oil corporations and also led to unemployment. Nevertheless, the shale industry survived the catastrophe as the US government came to rescue. In the current case, Saudi may have thought of killing two birds with one stone, but who is the real underdog here, it is yet to be seen.
Who will be the Winner?
In the Putin-Salman faceoff, experts are still pondering who will blink first. While comparing the major contributors to economic growth of both countries, Russia has more diversified economy than Saudi, because of its strong defence industry, which it’s the second largest exporting country in the world after the US. In contrast, Saudi Arabia’s oil-dependent economy will be hit strongly from its self-inflicted price cuts, whereas Moscow can survive the next six years since it has more cash reserves, as stated by Russia’s Finance Minister Anton Siluanov. If the oil prices stay at USD 30 or lower during the whole year, it would become obligatory for Riyadh to restrict its social expenditure, in addition to postponing the lavish initiatives under its “Vision 2030 Economic Diversification Program”.
Nevertheless, the collapse of Russia-Saudi Partnership was a big victory for Igor Ivanovich Sechin, CEO of Rosneft, one of the closest ally of Vladimir Putin. He was outspokenly against Russia’s participation in OPEC+ since the beginning. According to Lukoil Vice President Leonid Fedun, the Kremlin had no specific discussion with top national oil producers, yet he was aware of the fact that some of the Russian state-owned corporations had lobbied for this decision. Moreover, it was coup d’état for right-wing Russian economists who were determined to protect national interests over international cooperation.
Way Ahead
Not many can predict what is going to happen subsequently, since the additional concerns of COVID-19 on the international economy are still under the clouds. Though, it’s clear, that the reduced demand for oil and its price have placed a dent in the Russia-Saudi alliance for the time being, and its consequences will be felt ubiquitously, including the US.
The global oil market may soon pull through from the preliminary setback, but the energetic American shale industry might be severely affected by a superficial ally which the US had gone to huge extents to appease. Eventually, both Russia and Saudi have placed their bets on who will be the first to blink. They both have reasons to consider that they took the right decision. There are reasons where both, or either one, might be in the wrong way. But it’s clear, both are preparing for short-term efforts to induce the other to succumb on their terms and conditions.
