Explainer | Why did Saudi Arabia start an oil price war?
- Global oil demand was already in the doldrums amid widespread restrictions on trade and travel in the wake of the novel coronavirus outbreak
- But Russia balked at oil production cuts, the Saudis slashed prices in retaliation and global markets went into a tailspin on Monday
“With demand already falling like crazy, the timing of this is horrible,” said Jim Krane, fellow at Rice University’s Baker Institute of Public Policy in Houston. “It’s a lot of oil with no place to go.”
What happened?
Saudi Arabia, the world’s second largest oil producer, started a price war over the weekend when it slashed crude prices by the largest margin in two decades and said it would ramp up production.
Analysts say Riyadh’s moves, which on Monday caused international benchmark Brent crude prices to crash to US$33 a barrel from nearly US$69 at the beginning of the year, are an attempt to demonstrate Saudi Arabia’s dominance of global oil markets. The US benchmark West Texas Intermediate on Monday also sank to US$27.71 a barrel.
“A price war is a blunt instrument,” said Krane. “It hurts everyone who produces oil. It’s like a bunch of friends holding their breath to see who can hold it the longest.”
While Saudi Arabia has the wealth and oil resources to outlast many other countries, experts say these moves will not come without a cost for Riyadh, as its economy is dependent on oil money.
What made Saudi Arabia cut oil prices?
Global demand for oil had already fallen for the first time in a decade because of the outbreak of coronavirus, which causes a pneumonia-like illness known as Covid-19 that has killed almost 4,000 of the more than 110,000 people it has infected worldwide so far.
Friday’s talks between Opec and Russia, which have jointly supported oil prices since 2017, were initially intended to figure out a way to bail out the global oil market.
But after Russia’s refusal to cut production and the subsequent collapse of negotiations, crude oil prices sank a further 10 per cent.
Russia claims it refused to cut supply because it is waiting to see what the full impact of the outbreak will be on oil demand, but experts say Moscow may also be hoping to cut the knees out from under US domestic shale oil production after Washington sanctioned Russian energy companies.
Amy Myers Jaffe, an oil and Middle East expert at American think tank the Council on Foreign Relations, told The New York Times, “If you’re Russia, it’s worth it for you to take a three month price hit to see if you can knock out US oil exports.”
Jaffe said that the divergence in Saudi and Russian strategies “signals that the relationship between Saudi Arabia and Russia is on the skids”.
The US produced 18 per cent of the world’s oil supply in 2018, compared with Russia’s 12 per cent, according to the US Energy Information Administration – and has attracted customers who could have otherwise bought from Russia.
However, the group’s analysts said they “do not see this as a strategic break between Russia and Saudi Arabia, nor do we draw any direct connection between the Opec events and the arrests of Saudi royals last week.”
How could this affect other countries?
If the low prices continue, other oil producers may have no choice but to scale back production.
Experts say Saudi Arabia has the capacity to boost production faster than Russia can, and could even pull some supplies from storage to increase exports quickly.
If the global economic damage resulting from the coronavirus outbreak is long lasting, Riyadh may recalibrate its position, according to the Eurasia Group, but a major incentive for Saudi Arabia to keep prices low is China.
Chinese oil giants set to cut output, dividends after oil crash, analyst says
China has historically stockpiled oil during times of low prices to avoid having to purchase when prices are high, and could be a primary buyer of the Saudi’s discounted oil. China consumed nearly 14 million barrels a day in 2018, second only to the US, which consumed nearly 20 million.
“If China has room in its strategic storage, this would be a great time to top it up,” said Krane of Rice University.
Indian oil refiners are also looking for good deals, after they recently snapped up unwanted barrels of crude oil originally destined for China amid the virus-led demand slump, Bloomberg reported, quoting R. Ramachandran, the refineries director of India’s Bharat Petroleum Corporation who said oil buyers would be “spoiled for choice”.
Aren’t low oil prices a good thing for consumers?
Many people around the world are foregoing travel and staying home to combat the spread of Covid-19 despite low fuel prices. Airlines have slashed routes and the hospitality industry has axed jobs in hotels and restaurants while people stay home, meaning cheaper prices will not necessarily lead to more demand for fuel until the outbreak is contained.
Major UK oil companies BP and Royal Dutch Shell lost nearly US$42 billion in combined market value on Monday amid the price shocks. According to equity research firm Redburn, Shell requires oil prices of US$65 a barrel to break even, and BP US$53 – last year’s average Brent price was US$64.
The International Energy Agency said on Monday that global oil demand could decline by as much as 90,000 barrels a day this year.
What else is going on in Saudi Arabia?
Power in Saudi Arabia is wielded by 34-year-old Crown Prince Mohammed bin Salman, who has consolidated leadership on behalf of his father, King Salman, 84.
The crown prince has cultivated a reputation for being unpredictable, ruthless and ambitious, and now controls the kingdom’s military, internal security forces and national guard.
Cranking up oil production right now during the virus outbreak is a pretty risky move, but Saudi Arabia is a country that can withstand low prices. MBS has certainly shown himself to be a risk-taker, and this does fit with his profile,” said Krane of Rice University, referring to the crown prince by his initials.
Saudi Arabia is currently producing about 9.7 million barrels of oil a day, far from its estimated capacity of 12 million barrels.
Shares of Saudi Aramco, the Saudi national oil company, plummeted by more than 9 per cent on Sunday. Bin Salman led the charge to take Aramco public in December of last year, and analysts say weaker share prices could cause the crown prince’s reputation to take a hit – and possibly even jeopardise his ambitious economic development programme, Vision 2030.
The Saudi royal court has accused the two men of “plotting a coup to unseat the king and crown prince” and they could face lifetime imprisonment or execution, according to The Wall Street Journal.