An oil price war amid a pandemic
Why two of the world’s largest oil producers unleashed a price war on oil market amidst an unprecedented collapse in world oil demand?
Scott McKnight, April 7 2020
The world oil market is in the midst of both a supply and demand shock. Oil prices fell to $63 per barrel in December 2019 to less than $20 per barrel at the end of March, prompting an intervention from President Trump to mediate between Russian president Vladimir Putin and Saudi crown prince Muhammad bin Salman and possible coordinated cuts from US oil producers.
On the demand side, the global dissemination of the coronavirus has led to restrictions on travel for work or pleasure, industrial production and consumer purchases, all of which require oil products, has eliminated some 10-12m barrels per day of oil demand and may reach 20m bpd in the coming weeks.
Extreme volatility: Price of West Texas Intermediate (WTI), early March-early April 2020, source: bloomberg.com/quote/CL1:COM
Facing this unprecedented collapse in oil demand, Russia and Saudi Arabia, two of the world’s largest oil producers and de facto leaders of the so-called ‘OPEC+’ arrangement, have fallen out, resulting in neither constraining production and the latter flooding the market as part of a price war on other oil producers.
Russian President Vladimir Putin (left) listens to Russian Rosneft CEO Igor Sechin against whom the US Treasury Department imposed sanctions on Tuesday February 18 2020. Photo via AP, File.
When did it begin?
Things are moving at warp speed in the world oil market. In early March, the Russian representative walked out of the OPEC+ meeting in Vienna, refusing to go along with the Saudi proposal to cut oil production by 1.5m barrels per day (bpd), with Russia asked to shoulder 300,000 bpd of that total. Why did Russia refuse? Two causes seem most persuasive. First, the Russians estimated that the collapse in demand is simply too great for even a disciplined OPEC+ to counter. The proposed cut, however distributed, would be a ‘drop in the ocean’, as the Russian deputy energy minister said. The problem was too big for OPEC+ to solve.
Second, the refusal to go along with the Saudi proposal may indicate that Russian oil policy may be changing. Since 2016 when OPEC+ was borne of the last oil price collapse, the arrangement has been a relatively successful instrument for multifaceted cooperation between Russia and OPEC member-states as well as a means for Russia to skirt sanctions imposed by the United States and European Union. Russia, for decades reluctant to bind itself to any OPEC production arrangements, now may again be looking to go it alone. It may also indicate that Igor Sechin, CEO of Russia’s largest oil-producing company Rosneft and vocal critic of the OPEC+ arrangement, has Putin’s ear on oil policy. It also likely means that this policy miscalculation will not be easily acknowledged.
The oil price war
Russia’s walking out stunned the Saudis and effectively ended supply management of the global oil market. The world oil market is now parachuting without a pack. Recognizing that Russia wouldn’t budge or recognize its own miscalculation, Saudi Arabia has instead chosen to flood the market, taking the unprecedented step to tap all of its spare capacity of 2.5m bpd to produce a maximum of 12.3m bpd. What appears like a kamizake strategy actually has a zero-sum logic at its core: continue to earn a profit—albeit much reduced—because Saudi’s lifting costs are famously among the world’s lowest, while also inflicting pain on other producers. This includes US oil producers above all, whose production peaked at 13.1m bpd in 2019 and made the US by far the largest oil producer in the world. Higher-cost producers, including Canada’s oil sands, China, the North Sea, and Brazilian shallow waters—will also feel the hurt, albeit with different degree of pain tolerance.
Making Russia see the error of its way may not be so easy. Russia profits from oil prices above $10 per barrel and whose government—still under sanctions and with limited access to capital markets—has built up its war chest and budgeted for $40 per barrel for the year.
Where to go from here?
Neither the Saudis nor Russians are known for backing down on oil policy—not in the short term anyway. This promises that April will be a painful month for oil markets. A lack of agreement among the world’s oil producers and continued collapse in oil demand is resulting in a pincer movement where storage capacity, already three-fourths full in late March, will have nowhere to go, inevitably sending oil prices even lower.
