Wikistrat Special Analysis on the Oil Price War Between Saudi Arabia and Russia

On 8 March 2020, Saudi Arabia initiated a price war with Russia, facilitating a 65% quarterly fall in the price of oil. The war ended when OPEC+ reached a deal to cut oil production on  April 12. To assess the causes for the outbreak of this conflict, it's potential implications for Saudi Arabia, Russia and other OPEC members and the future prospects of the OPEC+ deal's success, Wikistrat spoke to energy expert Robin Mills, Non-Resident Fellow for Energy at the Brookings Doha Center and CEO of Qamar Energy (Dubai).


Robin Mills is Non-Resident Fellow for Energy at the Brookings Doha Center and CEO of Qamar Energy (Dubai). He is an expert on Middle East energy strategy and economics. He is the author of two books, The Myth of the Oil Crisis and Capturing Carbon, columnist on energy and environmental issues at The National, and comments widely on energy issues in the media.



Insights


  • Moscow had political motives to fight the price war: Beyond fearing that by making further cuts American shale producers would gain more market share, Moscow also had political considerations for starting the conflict. Thanks to increased energy independence provided by shale oil production, Washington has been able to impose very stringent sanctions on Iran and Venezuela - both places where the Russians are deeply involved. The Russians therefore also had the political interest of not wanting the situation to continue and deepen.

  • Despite attempts to overproduce, the deal will hold for the foreseeable future: prices are going to go lower than they are now because the oil market's still under huge strain. Compliance with the deal will be far from complete. 10-million-barrels-per-day cuts will actually translate into about 7.5 million barrels per day. Voluntary compliance will be hard to achieve, so holding on to the deal will be a chaotic process. Some will try to overproduce but will discover that there just isn't a market for their crude oil. Others will find that they can sell it, albeit at a low price, and will try to overproduce. This scenario particularly applies to the non-OPEC members of the agreement. This will put the deal under some strain, but it will ultimately be upheld though, just because the pressure on the market is going to be enough, at least to keep the main players – Saudi, its allies and Russia – in the deal.

  • Moscow was, in the end, less strong than it was portrayed to be: In the media, there's been a lot of stress placed on Russia's strong position. Russia's position, however, was not as strong as the media thought, or as Moscow itself thought it to be. Russian taxes have a benchmark of $15 per barrel, below which basically companies are not paying tax. Now the Russian oil price has gone down, companies are struggling to stay profitable with these prices. That shows you've had quite a sudden turnaround in Russian behavior, which has made Moscow willing to come back into this deal.

  • It is unlikely that Iraq will be able to comply with the deal: Beyond the Saudi allies acting as a single bloc, the other really significant player in OPEC is Iraq, second after Saudi Arabia, which has not really complied very closely with OPEC restrictions. It cut production a little bit during the OPEC-plus period, but not much. Its economy is weak, and its government runs a deficit even in good times. Iraq has always argued that it shouldn't be expected to cut so much because it's recovering from war, and from decades of lost ground. Iraq has always been a bit problematic, but, for a long while, the Saudis were reluctantly willing to tolerate Iraqi overproduction because, generally, compliance was very good.


Transcript


Wikistrat: How do you understand the oil price war between Saudi Arabia and Russia that we've seen playing out in the past few days?


Robin Mills: It was, as it turned out, a pretty brief war. For starters, we should go back to early March when the OPEC-plus meeting happened in Vienna and then fell apart without an agreement. Saudi Arabia realized, even at that point, that the supply/demand balance looked weak. They hadn't anticipated how bad the virus situation would get but, still, they could see it was having some impact on demand.


They wanted production cuts extended through the end of the year. The Russians were getting very reluctant, willing to extend the production cuts only for a short time. The Saudis had expected the Russians to cave, but Moscow held its ground, so the deal fell apart without agreement. The Russians had grown increasingly concerned, I think, that they were giving up too much to US shale oil producers and that further cuts would just open more room for US shale production growth.


Russia didn't like that from a market point of view nor from a political one, but the Saudis kept on putting more stress on the negative supply/demand balance. Then, when the deal broke down, the Saudis realized they were in a price war and they decided to go at it very aggressively because that's probably the best way to win a price war: going very hard at first, without allowing other countries to adjust.


Thus, they made extremely aggressive cuts in their official selling prices. They promised to increase production to its maximum and that, in the longer term, they would increase production capacity. And those official selling prices were particularly targeting some key Russian markets, particularly in Europe. So, that's really the price war that they embarked on. Now, I think, when they embarked in early March, they had no idea how bad the coronavirus situation would get and how much demand would be destroyed. Over the month and a half since then, the situation's become very different because of the enormous decline in global demand.


Wikistrat: What do you understand the Russian strategy to be? And what objective was Moscow trying to achieve during this brief war?


Robin Mills: The Russians were not comfortable making even deeper or longer, extended cuts because of the issue of US shale. Russia felt they'd already given up too much market share to US shale production. And they thought that further cuts would just revive that and rescue US shale, which, at that point, was a starting look a bit shaky.


There’s a political element to this confrontation. Beyond economic considerations, the US had been using its shale oil production as a diplomatic tool that had encouraged the US to put very stringent sanctions on Iran and Venezuela – both places, Venezuela in particular, where the Russians are deeply involved. It encouraged them to put sanctions on Russia, both on investment and technology suppliers for the Russian oil and natural gas industry, namely by targeting the Nord Stream 2 pipeline into Europe in the attempt to make the US LNG a competitor to Gazprom in order to squeeze out some Russian gas into Europe.


The Russians had, thus, a market view and an economic view, but they also had the political view that they didn't want the situation to continue and deepen. The Russians also felt, at that point, in early March, that economically they could cope. With a relatively low foreign debt, a budget break-even price of about $42 per barrel, and very substantial foreign currency reserves, Moscow felt that it could survive a period of low oil prices. It did not realize how low prices were going to go or how much demand would be destroyed.


Wikistrat: What was Riyadh’s strategy during this war? What objectives were the Kingdom trying to achieve by playing with the prices so drastically?


Robin Mills: Saudi Arabia wanted an extension to dig deeper production cuts because they saw that the market balance wasn't looking good in early March. The Saudi position in general, and particularly under the fairly new oil minister, Prince Abdulaziz, has been quite intransigent – they've stuck to their position. They thought the Russians would back down when they demanded longer production cuts and they misread them; Moscow didn't in that instance. But then, Saudi saw that the market balance didn't look good and they wanted further production cuts. When the Russians walked away, the Saudis felt they had to respond aggressively because, if the Saudis had continued with their own production cuts, OPEC-plus would've been finished. It was clear that the Saudis would cut no matter what. Basically, the Russians, or anybody else, could free-ride on Saudi cuts.


As such, the Saudis didn't really have a choice but to go ahead and make unilateral cuts. The Saudis could have just kept the production level as it was instead of cutting further, thus pursuing a midway strategy. However, that's never desirable because it doesn't really achieve either goal while it also not really defending prices or market share. The Saudis thought it was better to enact a very aggressive response and they initially tried to punish Russia by being very aggressive, by attempting to squeeze Russia out from some markets and, therefore, cut, setting prices in the US and in Europe very aggressively. After a while, the Saudis realized that, probably, the main losers in this were not so much the Russians, but the American shale oil producers. From a market point of view, that was fine too, if it allowed the Saudis to regain some market share.


This is about really an unprecedented decline in demand. The loss of demand in April could be 25 or 30 million barrels per day, 20 to 30% of global oil supply. The OPEC cuts that have been agreed are a quarter of that.

Wikistrat: How do you see these tensions between Russia and Saudi impacting other members of OPEC, like the UAE and Iran?


Robin Mills: Other members of OPEC, of course, have their own stances on matters, but some, like the UAE and Kuwait, usually end up following Saudi. Close allies of Saudi Arabia operate almost as a block. Then there’s another block of countries that aren't bound by opiate restrictions at the moment, because of political issues: Iran, Venezuela and, then, Libya are not able to really control their production, nor economically able to cut it.


Further, there are other smaller producers, like Equatorial Guinea, whose voices don’t really count. The other really significant player in this is Iraq, a very large producer of oil, second in OPEC after Saudi Arabia, which has not really complied very closely with OPEC restrictions. It cut production a little bit during the OPEC-plus period, but not much. Their economy is weak and its government runs a deficit even in good times. Iraq has always argued that it shouldn't be expected to cut so much because it's recovering from war and from decades of lost ground, among other arguments.


Iraq has always been a bit problematic, but, for a long while, the Saudis were reluctantly willing to tolerate Iraq overproduction because, generally, compliance was very good. If you then add up all the compliance average of other countries, I'll bet compliance is still well over 100%.


Wikistrat: How do you think that the continued spread of the epidemic will impact the relationship between the different players in this conflict?


Robin Mills: The virus outbreak caused an enormous decline in world demand, which is still ongoing and we're only less than a month into this period of crisis. It's been a month since the OPEC-plus deal broke down and it's a month since lockdowns started across European countries, in the US, India, and so on. Obviously, in China, it's been going on for a bit longer, although China's somewhat getting back to normal.


This is about really an unprecedented decline in demand. The loss of demand in April could be 25 or 30 million barrels per day, 20 to 30% of global oil supply. The OPEC cuts that have been agreed are a quarter of that, perhaps. This is an unprecedented challenge that cannot be met by OPEC or OPEC-plus alone. This explains why OPEC-plus countries have been so keen to bring in some support from the G20 countries, from the US, and others in cutting production. Politically, it's proved impossible for those countries to commit to cutting production voluntarily. But what they've kind of agreed is, "Well, the market is going to cut for us, because some producers simply can't produce at these prices."


Wikistrat: As such, has COVID-19 led to the involvement of external actors in the resolution of this war?


Robin Mills: Had the virus outbreak not come along, or had it not been very serious, the OPEC-plus deal would have broken down and it might've gone on for quite a while, because Russia wouldn't have been able to cope with a price war, under those circumstances, thus no need for talks. However, as it is, of course, Donald Trump's got very deeply involved because of the damage to the US shale industry and because of the political pressure he's come under from various oil-producing states.


When we look at the oil prices, we're all concentrating on headline prices for Brent and WTI crude. But, if you look at the physical market, that's under far more stress. We've seen Russian crude slipping to $10 a barrel. So that's putting a much more direct stress on certain producers, who are either not able to sell their crude at all, or only at very low prices.

Wikistrat: In your assessment, what other factors influenced this situation? Are there any hidden factors not discussed by the media looking at the devolution of this oil price war?


Robin Mills: When we look at the oil prices, we're all concentrating on headline prices for Brent and WTI crude. But, if you look at the physical market, that's under far more stress. We've seen Russian crude slipping to $10 a barrel. So that's putting a much more direct stress on certain producers, who are either not able to sell their crude at all, or only at very low prices.


There's been a lot of stress put in the media on Russia's strong position. I don't think Russia's position is as strong as the media thought, or as Russia thought it to be. The Russian taxes have a benchmark of $15 per barrel, below which basically companies are not paying tax. Now the Russian oil price has gone [inaudible 00:12:48] the supply oil revenues, the Russian budget drives up entirely. Still, companies are struggling to stay profitable with these prices. That shows you've had quite a sudden turnaround in Russian behavior, which has made Moscow willing to come back into this deal.


Wikistrat: Are there any other players involved in this conflict that are under the radar, which are not really discussed in the media’s coverage of this war?


Robin Mills: I suppose it is important to ask oneself what's going to happen to the weaker countries if prices remain at these levels. What's going to happen to Venezuela, Iraq, Nigeria, Libya, and possibly other countries who haven't come under the radar as being under strain so much, but who are still under pressure, like Algeria? There's not much they can do in market terms; they can't really cut production, but politically they're under threat. If there's a major outbreak of conflict in a country, or perhaps in a political system, that might have implications for its oil supply.


Their oil supply may continue, shielded from the conflict, but it could also be completely interrupted. Nigeria in the past has lost hundreds of thousands of barrels per day for conflict in the Delta. Iraq has been through various phases of conflict. Libyan oil production, of course, is shut down almost entirely at the moment, but Libyan production could come back as well – that's also another wild card.


Prices are going to go lower than they are now because the oil market's still under huge strain. I think compliance with the deal will be far from complete.

Wikistrat: What do you expect to happen in this conflict in the coming months, even after the deal that was reached yesterday?


Robin Mills: Prices are going to go lower than they are now because the oil market's still under huge strain. I think compliance with the deal will be far from complete. The headline number of 10-million-barrels-a-day cuts will actually translate into about seven and a half million BPD. Not all of these countries will voluntarily comply, and compliance is thus going to be very chaotic. I think some countries will try to overproduce but will discover that they just can't. That there isn't a market for their crude oil or they just can't sell it profitably.


Some others will find that they can sell it, at least a low price, and will try to overproduce, because who knows if there will be a market there tomorrow. This scenario particularly applies to the non-OPEC members of the agreement. This will put the deal under some strain, but I think it will ultimately be upheld though, just because the pressure on the market is going to be so much and people will realize just how much worse the situation can get. This line of thinking will be enough, at least to keep the main players – Saudi, its allies, and Russia – in the deal.

US shale oil, at these prices, is going to collapse in production pretty quickly

Wikistrat: Do you think the continuing impact of COVID-19 will push both Russia and Saudi Arabia to maintain this deal?


Robin Mills: I think so. They're going to realize just how bad it can get if they start overproducing again. US shale oil, at these prices, is going to collapse in production pretty quickly. That will create some more market share for them automatically. The worry that this deal was somehow going to save shale oil… probably, that worry has gone away because this market crash, as it currently stands, is going to cause trouble not just for shale oil, but for other producers as well.


Wikistrat: Are there any other points which you think are worth mentioning in this context of this conflict or with regards to the deal that was just reached yesterday?


Robin Mills: Yes. Something that I’d like to highlight, looking at it from a domestic US political point of view, is the way the US debate has turned around from even a few months ago talking about NOPEC, trying to outlaw OPEC, to suddenly realizing that OPEC actually has a powerful influence on the world oil market and why it's in some way favorable for US oil-producing states. You've seen Texas and other oil-producing states, like North Dakota out there, arguing for possible production cuts. That would have been inconceivable even a few months ago.


This puts the US in a funny position because there are some states that benefit from this, mostly historically Republican states. On the other hand, there are some states that don't want higher oil prices. The whole new philosophy of US foreign policy built on so-called energy dominance has now proved to be very shaky. And yet, can the US really abandon that idea, now that it just got used to the idea of being energy independent?

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