Satvik analyses the recent tussle in the global oil market which is complex and rather dangerous for the world not in what it focuses on but on what it does not focus.
While the beginning of the year 2020 has been a hell of a ride for the average
citizen, from a heated political escalation between the global superpower and the
the self-proclaimed leader of the Shi’a Islamic world-threatening a 3 rd World War to
the spending of the March equinox in quarantines to protect ourselves from the
lethal outbreak of COVID-19 (Coronavirus Disease, reported for the first time in
December 2019 in China).
The outbreak has managed to utterly impede our “business-as-usual” and has
begun to puncture the global economy – according to some accounts, even
threatening a global recession within a few months.
The virus outbreak has already driven down oil demand in various Asian countries
such as China and South Korea which are some of the largest consumers of oil and
also, the worst affected by the viral outbreak. A tank in demand was met by a
unilateral call by the OPEC leader Saudi Arabia to cut oil production by all OPEC+
Russia decided to ignore this decision and continued producing oil at the same
scale as it had before reduced the prices of its exported crude oil to somewhere
around 30$ per barrel on March 7.
Saudi Arabia’s young leader, Mohammed bin Salman, known for making bold
(although not successful) decisions decided to flood the global market with oil
bringing down prices for Saudi oil to about 25$ – 28$ per barrel in its attempt to
outcompete Russian prices.
While this may seem like a great game of throwing in all cards in order to get the
other members to submit but there is a greater backstory to it which seems to
raise the stakes even higher.
In 2014, the United States entered the oil game with its revolutionary shale oil
extraction methods, which helped firms swiftly join in the quest of capturing a
greater share of the global oil market. The USA had managed to produce 4 million
barrels a day, while having started from 0.4 million barrels per day (BPD) about
seven years before that.
Such a quick rise in the shale productions gained serious confidence from
American firms investing in shale productions. Harold Hamm, a pioneer in the
discovery of shale oil remarked “For the next 50 years, we can expect to reap the
benefits of the shale revolution. It’s the biggest thing that ever happened to
America” (perhaps apart from the two World Wars).
The Saudis responded the next year by flooding the market with oil to regain the
market share being sliced away from them. This effectively drove the oil prices
down for a while. Although it began to strain the financial resources of the
country, it had a few solid billion dollars in foreign exchange reserves to help
them sail through the short-term strain for the regain of their long-term oligopoly
on oil. Here it was only a matter of time before the American investors would
withdraw funds from shale oil producers who, the Saudis hoped, wouldn’t have
been able to keep pace with the reduced prices.
Yet, the US shale industry continued to persist and even expand. Riyadh’s plan
had clearly backfired. Growing US exports and Saudi’s overproduction resulted in
a glut in oil in the global market and the prices continued to be in free-fall (just
like the present stock prices but that deserves a different article altogether).
Saudi Arabia and Russia then focused their exports to China, which was in
desperate need for cheap crude during its economic slowdown of 2015-16. That
made these two even more reliant on the Asian markets.
OPEC and Russia signed a deal known as the “OPEC+” where both agreed to co-
operate their oil production to maintain profitability for both.
In 2018, the USA surpassed both Saudi Arabia and Russia to become the leading crude
exporter. It gave Trump way more leverage over Mohammed bin Salman and
Putin in the global energy market.
However, the Riyadh-Moscow alliance continued in essence – up until it faced a
severe setback in demand – that is, the COVID-19.
China, which had evidently become the favorite market of the OPEC+ alliance,
was thrown into recession and the demand for oil plummeted. Chinese refineries
cut their imports of foreign oil by about 20 percent in February.
This demand reduction signaled a drop in the prices for oil globally – to cope with
which reduction of supply was one solution to keep the prices stable.
This plunged all the member nations into chaos once again, evaluating their
strategies for the game of acquiring more profit in the oil market. Russia, in this
prisoner’s dilemma, chose to compete rather than co-operate production with
This manifested on 5th March 2020 when the cartel leader’s decision to slash oil
production by 1,000,000 BPD and “suggestion” for Russia to slash its production
by 500,000 BPD was outright ignored by Moscow.
Riyadh, as we mentioned, flooded the market with oil, especially in Western
European markets where Russian oil was trying to gain a foothold. This saw the
largest-ever drop in oil prices since 1991 of about 11$ in one day and then
continued shrinking of the price till the present 25-28$.
Russian Rosneft’s decision (which is the oil production organization in Russia) has
been a subject of speculation. While Saudi Arabia claims that Russia intends to do
this to keep all the profits for itself, USA believes its aim is to debacle shale-
producing firms in Texas and Dakotas, while Russia refuses any such “price war”
with Saudi Arabia and that the decision to continue oil production was its
sovereign right to do so.
Regardless of the intent, which in the Kremlin’s case is almost always not very
clear, Wall Street shares have fallen at 7 percent, forcing a trade stop shortly on
Monday. Some firms have fallen as much as 45 percent in recent days.
Russian Energy Minister Alexander Novak said they saw no grounds to enter
negotiations with OPEC+ partners, and hinted that Kremlin could increase
production by 200,000 BPD in April. At this, Saudi Arabia pledged to raise
production by 2.6 million BPD in April.
A game of chicken?
Here Russia maintains a large foreign exchange reserve and gold reserves to
cushion the economic impacts of the oil tussle. It has spent the last five years
tightening its budget and building up $550 billion in reserves that officials say will
let it cope with oil prices between $25 and $30 a barrel for up to a decade if need
be. On Monday, Russia’s finance ministry said that it would draw from its $150
billion national wealth fund in order to supplement the budget even if oil prices
stay low. If crude sells for an average of $27 a barrel—it was in the low-$30s most
of this week—Russia would need to draw $20 billion a year from the fund to
balance the budget.
The biggest losers in any oil-price war will be high-cost U.S. shale producers;
driving the price down would both inflict economic harm on the United States and
weaken its ability to wield its beloved tool of international coercion: sanctions,
which it recently imposed on Venezuelan oil producers and Russian, by extension,
for dealing with them.
Russia’s right—the shale producers, loaded with high-yielding debt, is a fuse
that could blow up the whole U.S. corporate debt market. If Russia wants to push
buttons to cause anarchy in the United States, that’s a good one.
For the Saudi prince, it seems to have been a risky gamble. The stakes for Saudi
Arabia go beyond short-term persistence. Mohammed bin Salman has an
ambitious plan—Saudi Vision 2030—to spend billions to transform the Saudi
economy from an oil-exporting state into one resembling a modern, diversified
economy. But that requires ready cash, which will be in short supply the longer
the oil-price war continues.
“They knew that going in, and they figured the Russians would give in quickly,
thinking a 30-day war, but the Russians think the Saudis will also give up quickly.”
Jean-François Seznec, an expert on oil and Saudi Arabia at the Atlantic Council
said. “It reminds me of the First World War when France and Germany went to
war thinking they’d be home by Christmas and spent four years in the trenches,
that’s why this is so dangerous—it’s a mirror image.”
What does it mean for you?
However, prices in India are likely to remain unaffected because the exchange
rate of rupee in comparison to US dollars hasn’t been lower, having been 58-59
INR/USD in 2014 and 73-74 INR/USD today. Add to that the Rs. 19.98 per liter
charged by the Central Government as excise duty and the dealer commission of
Rs. 3.55 per liter.
State governments then go on to charge VAT of as much as 27%, inflating the
costs further, causing the petrol which is bought at Rs. 32.93 per liter in the
international market to cost Rs. 71.71 to the average consumer, which is still
lower to Rs. 75.18 per liter recorded on 1 st Jan and definitely lower than Rs. 84 per
liter recorded on 4th October 2018.
Unfortunately, the fall in the global oil prices comes at a time when the entire
the nation has a lockdown-like situation and the “undeclared emergency” which some
opinionated individuals have been complaining about since a few months ago
might turn into a legitimate national emergency – and this time it does not stem
from the ambition of a few Gandhis trying to remain in power but a peril, so large,
that it might destroy the present demographic composition of the entire world.
– Satvik Tripathi,
Writer, Bharat Bhagya Vidhata.