The Financial Express

Price war of oil poised to escalate

Mushfiqur Rahman | Published: March 27, 2020 21:41:47

Price war of oil poised to escalate

It has been discussed for several weeks in the media that the Russian Federation and the Kingdom of Saudi Arabia (KSA) have been 'fighting' over crude oil market share. Some analysts have been preferring to call it as a 'game' between the two oil rich countries and eagerly waiting to watch who will blink first.

The latest crude oil war began when the OPEC+Plus negotiations in Vienna failed on March 6, 2020. Russia, the most prominent non OPEC member and a major oil producer and exporter was not ready to take the OPEC (Organisation of the Petroleum Exporting Countries) offer to cut 1.5 million barrel crude oil production daily. If the proposal was considered, the main looser would have been the Russian Federation as the most prominent member country from the non-OPEC group. The OPEC countries wanted to reduce production by one million barrels a day and asked Russia and others to reduce additional half a million a day. This proposal was rejected by Russia as the fallout of the extra cut would hit its production most.

KSA in response started to increase its oil output to over 10 million barrels a day and offer discounts to European and Asian consumers targeting to squeeze mainly Russian oil export markets. Despite the fact that the crude oil demand during this quarter will rather decline further (some experts consider that the demand will slump more than the period of 2008 financial crisis). Saudi Arabia prepared to pump an extra 2.6 million barrel in April and United Arab Emirate (UAE), another OPEC member country, can add another one million barrel a day. Russia is promising to boost production as the price war for crude heats up. The actions taken by the OPEC and non OPEC member countries for increasing oil production  resulted in oil price slide drastically. Oil prices had declined below the mark of 1991 Gulf War period.

Experts predict that oil price might slide to US $20 a barrel or even below as Saudi Arabia and Russia have been continuing to flood the market with increased supplies. Oil prices have been pushed down (Brent Crude is struggling now a days to maintain nearly US$30 per barrel) to 20 years low this week. The market has been flooded with over-supply but at the same time global demand for crude oil has been severely reduced due to the Covid 19 pandemic. Analysts from Goldman Sachs Group Inc., to Citigroup Inc. anticipate oil prices will decline further in the coming months.

There are no signs that the Russian and Saudi Arabian leaders will engage in dialogues despite the huge losses they have been incurring from oil revenue short falls. Russian sources report that it will earn 3.0 trillion Ruble lower than planned this week from oil and gas revenues. Russian President's spokesman Dmitry Peshkov said on March 16, 2020  to news agency TASS that 'Putin does not have plans to contact either the Crown Prince or the King of Saudi Arabia'. As reported, Russian Finance Minister Anton Siluanov said this week Moscow now expects a budget deficit. Russian currency Rubble experienced heavy losses and  has been trading at 77.5 against the US dollars (it had fallen to its lowest level in five years and was traded at 80.5 against the US dollar on March 19,  2020). Traders do not expect the currency to recover strongly anytime soon. Russian stock markets are also experiencing bearish trends. But Russian leaders have been promising to increase oil production up to half a million barrel a day. Russians are trying to assure the market that they have enough resources to cover budget shortfall for six to ten years even if the oil price remains at $20-$30 a barrel.  Al Jazeera reported on March 15, 2020 that Russia had US$ 440 billion foreign exchange reserves and the KSA $490 billion, and that the KSA needs around US$82 a barrel to balance its budget. On the contrary, Russia can balance its budget (as  International Monitory Fund predicts) if the oil is traded at US$42 a barrel.  Also, Russian economy is more diverse than KSA and Russia is less dependent on oil revenues than KSA. Analysts argue that Russia has a better fiscal, financial, and political leadership capacity compared to KSA for sustaining a long term crude oil war.

KSA has been trying to claim that it can adapt to lower oil prices, but at US $30 a barrel, the Saudi foreign currency reserve will deplete fast and the government will be compelled to reduce spending for important national projects. In the longer-term, fund shortages will challenge the implementation of the  ambitious Vision-2030 plan of Saudi Crown Prince Mohammad bin Salman.

One of the targets for KSA and Russia for flooding the market with oil at extremely low price is to push the US oil producers out of the market. US has emerged as the single largest oil producer due the shale oil productions within its soil. Both Russia and KSA are strategically interested to push the US shale oil producers out of the market even at their huge economic costs for several years. This is purely not an economic battle, rather a geopolitical one.

In 2014 when the OPEC led by the Kingdom of Saudi Arabia boosted its oil production to protect its market share, Brent crude price slipped from US $ 112 per barrel (in June 2014) to below US $32 per barrel (in January 2016). This has compelled more than 120 US companies to file for bankruptcy between August 2015 and May 2017. The shale oil drilling activities were reduced to nearly half as the shale oil break-even price was US $ 60-$90 per barrel. Shale oil production companies in the USA have learnt how to rationalise their costs and survive when the oil prices are low. In 2017, the EIA of the USA concluded that approximately 50 per cent of the shale oil deposits would be able to justify their existences if the oil prices drip at around US $30 per barrel.

Part of the Russian media holds the opinion that the shale oil producers will be compelled to reduce their productions (as the weaker companies will be out of business) and significantly cut their profits as a result of the crude oil war situation. The OPEC+Plus deal restricted productions and helped maintain crude oil prices at a sufficiently balanced level. The 'high' oil price enabled shale oil producers to comfortably carry on their businesses. Now, because of the very low crude oil prices prevailing in the market, shale oil producers have to squeeze their production and allow space to OPEC and non OPEC oil producers to expand the supply gaps (although it is uncertain whether the corona pandemic will invite global recession and less demands for oil in the future).

US President Trump said on March 19, 2020 that he would get involved at an appropriate time in the price war of oil and 'he was trying to find some kind of medium ground'. The Guardian newspaper reports (March 19, 2020) that the Trump administration in the USA has been considering a diplomatic push to KSA to reduce oil production. The same authority may use more economic sanction threats to Russia for reducing oil output to stabilise the market. After all,  the shale oil boom has enabled USA to become the largest oil producer overtaking KSA and Russia.

 Mushfiqur Rahman is a mining engineer and writes on energy and environment issues.




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