The impact of coronavirus has destroyed the demand for oil and neither Saudi Arabia, Russia or the United States will escape the resulting price war unscathed.
Faced with an escalating crisis brought on by the global outbreak of COVID-19, Saudi Arabia made a conscious decision to increase oil production in order to avert a potential oil-price collapse. The move sent an already faltering global economy into a tailspin.
The trouble began at the beginning of March, after Russia rejected an ultimatum from Saudi Arabia to cut oil production in light of falling prices. The Saudi response was to effectively flood the oil market with an additional 2.6 million barrels a day at a dramatically discounted price.
History has taught us that the Saudi response has been a common experience. Between 1981 and 1985, the Kingdom cut oil production drastically in light of rising supply from the North Sea, Siberia and Mexico. When the move amounted to little benefit, Saudi Arabia slashed their prices and increased production. It did the same in November 2014 after asking Russia to cut oil production, leading to yet another depression in the oil industry. At the time, Saudi Arabia’s deputy economic minister said “if we don’t take any reform measures, and if the global economy stays the same, then we’re doomed to bankruptcy in three to four years.” The statement was a telling indication that the Saudi leadership was well aware of the devastating consequences of such a strategy.
Oil markets have faced rising and falling prices since the start of 2020. In fact, days after the new year began, oil prices dipped sharply and then rose after the United States assassinated Iranian General Qasem Soleimani, bringing the world to the brink of a major war. This was always going to be short-lived however, in light of the long-term impacts of the COVID-19 crisis.
“Price action in the oil market is testament to some of the challenges we face,” economist Cameron Bagrie told MintPress News via email.
The oil industry is obviously facing a demand shock and is in trend decline. But the responses are testament to that old adage: where push comes to shove it’s ‘every man (or woman) for themselves.’”
We need group interest as opposed to self-interest around the globe in response to rising economic and health challenges.”
Saudi chickens are coming home to roost
Initially, the Saudi sentiment appeared to be to “allow this thing to go on for a while to bring structural change to the industry,” according to one Saudi source. That sentiment, however, may not continue in the long run.
The impact of coronavirus has destroyed the demand for oil. A consumer-based economy is doomed to struggle when there are no more consumers. As domestic and international flights across the globe grind to a halt and as many countries impose lockdowns and self-isolation procedures, both personal and commercial demand for oil has dissipated.
Saudi Arabia announced this week that it would reduce government expenditures by $13.2 billion USD, or close to five percent of its budget spending for 2020. According to the state-run Saudi Press Agency (SPA), the Minister of Finance and Acting Minister of Economy and Planning took the measures “in light of the noticeable development in the public finance management, and existence of the appropriate flexibility to take measures in the face of emergency shocks with a high level of efficiency.”
The real reason for this move though (as stated by the Saudi government itself) was to take measures to “reduce the impact of low prices of oil” with additional precautions to be taken to deal with the expected drop in prices.
According to Reuters, Saudi Arabia was already well aware of this pending situation. Before the OPEC+ talks fell through, Saudi Arabia asked government agencies to propose a 20 to 30 percent cut in their budgets due to the decline in oil prices, anticipating that talks with Russia were always going to be problematic.
Economists are expecting Saudi Arabia’s budget deficit to grow significantly from 4.7 percent of its GDP in 2019 to well into the double-digits. As it stands, the International Monetary Fund (IMF) has said Riyadh needs oil at $80 a barrel in order to balance its current 2020 budget. Flitch Ratings goes one step further and assesses that the Kingdom will need oil prices at $91 a barrel, assuming everything else runs as normal. As of writing, Brent crude oil is barely at $30 a barrel.
In order to cope, the Saudi government announced it will put a stop to major projects and investments and the Saudi wealth fund will diminish at an astonishing rate. One must bear in mind that Saudi Crown Prince Mohammed Bin Salman (MBS) had only recently unveiled his Vision 2030 plan, a symbolic move to diversify the Saudi economy away from oil. It is difficult to see how this vision would be realized at the current rate, given the plan relies on enormous government spending.
Further, Aramco, the Saudi national oil company that recently went public for the first time in its history, is unlikely to convince investors to bank on Saudi oil. The Saudi kingdom may have no choice but to pick up the slack, and to do so as soon as possible.
On the other hand, analysts are far more confident that Russia can weather the storm to a greater extent than Saudi Arabia can. By all accounts, Russia is in a stronger financial and political leadership position than its Saudi counterpart. According to Oil Price, Russia’s budget breakeven price is $40 USD and can produce over 11 million barrels per day without facing many repercussions.
The impact on US-Saudi relations
The United States has just recently become the largest oil producer in the world. Saudi Arabia’s decision to tinker so heavily with global oil markets is therefore sure to hurt U.S.-based oil companies. As the Financial Times explained, “the Russian-Saudi crude war threatens America’s growing shale industry, hurts debt-burdened US oil majors and exacerbates the pressure on collapsing stock markets.” Despite this, the Trump administration is unusually silent about this particular topic. Given how outspoken Donald Trump can be, and given his pledge to put “America first”, his turning a blind eye to what Saudi Arabia is doing to global oil markets is noticeable, to say the least.
One reason for this inaction may be that while U.S. companies will suffer, the U.S. strategy of deterring nations from forming meaningful alliances with adversarial nations, such as Russia, will always take precedence over anything else. What this current Saudi-Russia oil spat appears to confirm is that the in-roads Saudi-Russian relations were making over the last three years have been brought to a complete standstill. As one senior Washington-based legal source said, “we were concerned anyway that the Saudis were becoming too dependent on Russia because of the OPEC-plus deals and were listening too much to its [Russia’s advice].”
In 2018, when the world demanded answers from the Saudi leadership over the killing of Washington Post contributor Jamal Khashoggi, Russian President Vladimir Putin smiled as he high-fived MBS before taking a seat next to him. The two countries appeared to be set to start a new era of Saudi-Russian relations which would center around maintaining the stability of oil prices, as well as defense and arms sales. The damage done by this recent feud may be enough to undo prospective developments between the two nations, solidified when Putin’s spokesperson said that the Russian president has “no plans” to speak to MBS or his father anytime soon.
The other factor to bear in mind is that the Saudi strategy is to absolve itself of any fault and lay the blame squarely at Russia’s feet. As a Saudi source close to the royal court said, “the beauty of this is you can blame it on the Russians.” As the corporate media and the Trump administration are far too hesitant to irk Saudi Arabia too much, the belief that the Saudis can place the burden on Russia may end up being a valid one.
That being said, thirteen Republican senators did send a letter in mid-March urging MBS to reverse his decision, stating “the added impact of unsettled global energy markets is an unwelcome development.” The senators also questioned the notion that the Saudi Kingdom “is a force for stability in the global markets.”
NOPEC: the US could use to intervene if it wanted to
The U.S. has open to it a ‘No Oil Producing and Exporting Cartels Act’ (NOPEC) bill, which, if passed, could render it illegal to artificially cap oil and gas production, or to set prices, something Saudi Arabia has routinely done in recent history. The law would also pave the way for Saudi Arabia to be sued in U.S. courts.
In the past, Donald Trump vetoed the bill, presumably under Saudi pressure. As such, there are no real indications that Trump’s sentiment on this issue is set to change anytime soon. However, Trump may not make it through to the end of 2020 without being unseated, and the incoming president may have other plans for the U.S.-Saudi relationship.
Saudi Arabia, Russia and the United States will not escape this price war unscathed. However, the real victims of these tit-for-tat games of chicken are nations like Iran, who have seen at least a quarter of its oil rigs idled and the never-ending decline of its currency.
This may very well be another reason we can expect the United States not to intervene, given the situation may help Washington to achieve its long-standing goal of crippling the Iranian economy in a bid to implement regime change in Tehran.
In the meantime, the U.S. is continuing to edge closer toward a war with Iran in Iraq, with multiple attacks taking place even throughout this month. If that war happens, the least of anyone’s worries will be cheaper oil prices.
Feature photo | A Saudi trader talks to others in front of a screen displaying Saudi stock market values at the Arab National Bank in Riyadh, Saudi Arabia, Dec. 12, 2019. Amr Nabil | AP
Darius Shahtahmasebi is a New Zealand-based legal and political analyst who focuses on US foreign policy in the Middle East, Asia and Pacific region. He is fully qualified as a lawyer in two international jurisdictions.