Oil price wars, particularly between sovereign states, are rare and each one is a case study in its own right. Sometimes they are quickly patched up, but often they have profound economic and political consequences. The current struggle between Russia and Saudi Arabia has sparked the biggest crash since the 1991 Gulf War with oil prices dropping almost 40% overnight, from $50 per barrel to $31/bbl. Triggered by Russia’s walkout from a meeting of OPEC and non-OPEC ministers in Vienna on March 6 in the face of Saudi production cut demands, it is doubly unusual, coming amid one of the worst demand crises in history.
Following the breakdown of talks, and in apparent retaliation, Saudi Arabia made dramatic cuts to pricing and promised a production surge. It cut prices to Europe and Asia by between $6/bbl and $8/bbl, depending on the grade, directly challenging the core markets for Russia, whose crude is of similar quality. Saudi Aramco said it would ramp up supply to 12.3 million barrels per day – above its official capacity of 12 mb/d, suggesting it would draw on storage – and was instructed to boost its capacity to 13 mb/d, a task that would likely take several years. Saudi ministries reportedly had been instructed to prepare emergency budgets for an oil price of $12/bbl to $20/bbl.
However, Russia is unlikely to concede. Since the previous crash in oil prices in 2014, and also in response to U.S. sanctions, Moscow has cut its budget’s oil price exposure and built up its sovereign wealth holdings, albeit at the cost of stagnating living standards. Freed from restraints imposed by the alliance of OPEC and non-OPEC producers, OPEC+, Russia’s state giant Rosneft has said it could boost output by 300,000 b/d within a week or two.
Russia and Igor Sechin, chief of Rosneft, hope lower prices will improve the country’s geopolitical clout, by undermining the United States’ “energy independence” narrative. The shock to U.S. shale producers is partial payback for sanctions on Moscow’s new Nord Stream II pipeline to Germany and Rosneft’s trading arm for dealing with Venezuela.
OPEC and Russia may patch things up by the next meeting in June, but it is unlikely that this will involve adherence to the proposed yearlong 1.5 mb/d cuts that proved a deal breaker in Vienna. At best, the alliance might return to its agreed December 2019 production levels, or more likely something like the levels from 2017 through 2019. Of course, it took more than two years of price pain after the late-2014 crash to bring Moscow to Vienna, and, even then, many analysts were skeptical of real Russian cooperation.
Before that, there will be a period of massive oversupply. OPEC could not continue its cuts without Moscow, as that would nullify any threat to strike back against Russian overproduction .
The timely restart of operations in the shared Saudi-Kuwaiti Neutral Zone gives both countries, especially Kuwait, more firepower in support of OPEC’s plan to flood the market with cheap oil. The Neutral Zone is expected to regain its former output of about 500,000 b/d by the end of the year. The United Arab Emirates produced just over 3 mb/d in January, but the state oil firm, the Abu Dhabi National Oil Company, claims it will supply 4 mb/d in April, testing new capacity that has never operated before much above 3 mb/d. It will accelerate its previous plans to reach 5 mb/d by 2030.
Saudi Arabia, the UAE, and Kuwait are likely to act in coordination. Other countries can only hope to boost their own output to offset, partially, the price crash. Iraq could add about 350,000 b/d from state-operated fields, and Nigeria might find another 100,000 b/d.
Against this, Iran’s exports have already dwindled almost to zero, and the impact of the coronavirus combined with attractive Saudi pricing could force it out of its last remaining market, China, entirely. The price collapse and new U.S. sanctions could harm Venezuela, whose expensive heavy-oil production has actually rebounded a bit since November 2019. Libya’s output has been slashed to 120,000 mb/d by a blockade of the country’s main oil ports ordered by General Khalifa Hifter. A political deal could return it to recent levels of about 1.1 mb/d, but one of Hifter’s backers, Russia, may prefer to torpedo that by encouraging him to stand firm or vetoing resolutions.
With added supply from these countries, overall OPEC+ output could rise by some 3 mb/d to 5.5 mb/d very quickly. Meanwhile, the International Energy Agency, which coordinates energy policy for developed countries, has a base case that world oil demand drops 2.5 mb/d in the first quarter and 40,000 b/d in the second quarter of this year. With new non-OPEC production arriving from the United States, Norway, Guyana, and Brazil, the supply and demand balance already looked bad enough in December 2019 – before the outbreak of the coronavirus – for OPEC+ to agree to a further cut of 500,000 b/d. In the face of such an imbalance, the plummet in Brent oil prices from $50/bbl to the current $34/bbl looks moderate.
These low prices affect all oil producers, but the weaker ones are more exposed. Algeria’s energy minister, Mohamed Arkab, said the failure to reach a decision was “very negative” for producers. The Oil Ministry of Iraq, a serial undercomplier on quotas, commented that “flooding oil markets was not in the best interest of producing countries,” and the former finance and foreign minister, Hoshyar Zebari, tweeted, “The oil price crush recently will seriously damage #Iraq economy and finances and could cripple the country. No serious planning is in place unfortunately to avoid the catastrophe.”
Iran’s crude sales will struggle more in an oversupplied market, and now prices for its $10 billion per year of petrochemical sales and $3.5 billion of natural gas sales will be slashed. This is on top of the disruption caused by the country’s severe coronavirus outbreak.
Lower crude prices will drag down the price of liquefied natural gas contracts linked to oil, harming Qatar in particular. Even before the crisis, spot prices had crashed to record lows.
Even the more diversified regional economies will take a hit: reduced shipping through the Suez Canal; lower tourism and business travel through Egypt, Jordan, and the UAE; and slashed remittances to regional oil importers including crisis-hit Lebanon.
In January, the International Monetary Fund published a report arguing that, without changes in policy, the Gulf Arab countries would deplete their financial reserves by 2034, under a real oil price of $55/bbl. A few years of much lower prices will encourage world oil demand to rise to a degree, once the effect of the coronavirus ebb, but also bring forward the date of fiscal exhaustion. All Gulf currencies have long been pegged to the dollar (Kuwait to a basket of currencies), and the Omani riyal has come under particular scrutiny. At a $30/bbl oil price, the sultanate’s budget deficit would be some 22% of gross domestic product.
The price collapse may bring urgency for the real fundamental economic reform that the Gulf states have largely deferred over the past six years. Oman and Bahrain are looking at initial public offerings or strategic stake sales in their oil companies. They might sell part of refining or petrochemical units, but production assets would attract only distressed pricing at the moment. For Saudi Arabia, the idea of selling more Aramco shares at home or abroad must also be off the table. Yet the regional countries face the paradox that low oil prices spur the ambition for diversification but take away the means to fund it.
Meanwhile, a persistent price war will show Washington that being able to produce a lot of oil at high prices is not “energy dominance.” Shale oil firms were already under pressure from fatigued investors, slowing productivity gains, and maturing reservoirs. Within a year, their hedges will mostly have expired. Shale proved surprisingly resilient following the 2014 price crash, but it still lost 1 mb/d before the OPEC+ cuts took effect. This time, facing a much faster treadmill because of a higher base level, U.S. drillers need to replace some 250,000 b/d of natural declines monthly just to keep output flat.
A collapse in U.S. output over the next one or two years would return the market initiative to Russia and the Gulf states. But at low prices and with other things on their mind, Western policymakers will likely be complacent. The falling U.S. attention to the Gulf leaves the field open for others to contest it – regional powers Saudi Arabia, Iran, and Turkey, and outsiders Russia, China, and, perhaps, India.
There is no simple or immediate link between low oil prices and Middle East conflict and political collapse. But with Algeria, Sudan, Lebanon, and Iraq already in political transitions or economic crises, contagion is possible. The fallout from the walkout in Vienna will manifest in many places in years to come.