By Tanay Katiyar
The Saudi Arabia-Russia Price War and the COVID-19 pandemic caused major disruptions to the global oil market. Starting at the year’s high of $68.91, Brent Crude (BZ: NMX) closed at $31.13 on May 14th, one amongst the copious ramifications of the war. While some observers(Tong, 2020) have deemed this war to be a ‘double black swan event’, an examination into its geopolitical underpinnings reveals it to be a ‘single black swan’ event [1]. Given the rate at which the war unraveled and wreaked financial havoc, this article recognizes the 2020’s first quarter as ‘Oil’s Black Quarter’. Further, future geopolitical implications for renewable energy resources are discussed. This article employs a constructivist research approach.
The Price War Narrative and its Geopolitical Inspirations
The current pandemic is central to the price war’s narrative. In January, China suffered a major demand shock as it went into a lockdown. Consequently, Chinese oil refineries cut their output by about 1.5 million barrels per day (bpd) [2], leaving Very Large Crude Carriers (VLCC) stranded off the Chinese coast as local oil storages were crammed. This volatile oil climate in China, the world’s largest energy importer, sent off an alarming signal to the oil exporting nations.
Worried about this infectious demand shock as result of increasing lockdowns worldwide, Saudi Arabia proposed to prepone OPEC+’s meeting to February[3]. However, the early OPEC+ meeting didn’t materialise [4]. Instead, OPEC+’s Joint Technical Committee (JTC) recommended a 600,000 bpd production cut. While commentators found this reasonable [5], Russian authorities asked for time to scrutinize citing the political turmoil in Libya,which precluded production of 1,000,000 bpd, as a mitigating factor for declining energy demand, making any further cuts superfluous [6]. Nonetheless, many remained optimistic that an agreement would be reached in the March series of meetings in Vienna.
Instead, these meetings are observed to have precipitated the oil price war. OPEC deliberated for an additional 1.5 million bpd cut besides the existing 1.7 million bpd cut agreed in December 2019. Russia rejected this proposal and suggested extending the previous cut for an additional quarter [7]. Without consensus, the March 6th meeting was extremely brief [8], after which Russian Energy Minister Alexander Novak said: “…. from April 1st of this year onwards, neither we nor any OPEC or non-OPEC country is required to make output cuts.” [9]. This marked the end of the OPEC+ strategic alliance between Russia and Saudi Arabia. As retribution, Saudi Arabia majorly discounted its main export, Arab Light on March 8th. Further, it signalled increasing production to 12 million bpd, a target achieved on March 31st [10]. These actions constituted the oil price war of 2020.
Here, it becomes imperative to understand the source of discord between the two parties. Russian Deputy Energy Minister Pavel Sorokin expounded that the production cuts, while technically unfeasible for Russia, weren’t justified since COVID-19’s impact on oil markets was still obscure [11]. Further, Russian Presidential Press Secretary Dmitry Peskov dismissed the price war and cited other factors for reduction in oil prices [12]. While the actions of the two parties indicated otherwise, their geopolitical inspirations account for this dissonance.
Some commentators explain Russia’s dissent as an oblique measure to attack the US Shale Industry, which the Russians believe, have benefited indirectly from OPEC+’s cuts. Others interpret this as retribution for Washington’s sanctions on Rosneft for the sale of oil to Venezuela. While Russian officials dismiss this angle [13], there exists prior evidence that suggests Russia’s antipathy of US sanctions. Igor Sechin’s (Rosneft’s CEO) speech at the 12th Eurasian Economic Forum is a case in point. He posited: “Today the increase in the share of US oil on the global market is often achieved not so much via economic as via political methods — by ousting key players and foisting products.……., about a third of world oil reserves and a fifth of global output (Iran, Venezuela, and Russia) is now under American sanctions! At that, the United States virtually extends its jurisdiction over other countries, including the European Union, which is forced to comply with the US sanctions policy.” [14].
This speech gains further context when one notes that Russian commentators observe Sechin to be prominent in Putin’s administrative circles. Mikhail Krutikhin, a Russian energy analyst, further states that only Sechin called for a price war while other Russian oil executives insisted on co-operating with OPEC+ in Putin’s early March meeting [15]. Moreover, he interprets Russia’s initial refusal as purely ‘logistical’ [16]. Thus, one can infer Russia’s March 6th dissent to be coloured with Sechin’s interests. Others construe Russia’s actions as disapproval of Saudi backed opposition in Syria [17].
Similarly, analysts interpret Saudi Arabia’s actions as rash decisions of its crown prince Mohammed bin Salman (MBS). Allegedly, MBS dismissed his half-brother's (Oil Minister Abdulaziz bin Salman) advice to not engage in a price war [18]. However, Bernard Haykel, professor of Near Eastern Studies at Princeton, suggests that these actions signal a vital policy shift. With the proliferation of renewable energy and a shifting public attitude towards climate change, Haykel comments, “With a global clean-energy transition inevitable, he is desperate to cash out while the Kingdom still can…….” [19]. This insight seems prudent, given the enormous competitive advantage Saudi Arabian oil possesses.
However, the war’s economic analysis suggests that Saudi Arabia might have underestimated Russia’s resilience. In a price war, foreign exchange reserves are essential. While Saudi Arabia had $490 billion and Russia had $440 billion in reserves (mainly acquired after the 2015 oil shock [20]) [21], one must recognise that the Russian economy is more diversified. Moreover, to balance its domestic budget, Saudi Arabia required oil prices at $80, almost twice as much of Russia’s requirement [22]. The Russian oil industry also carries less debt, thereby offering leeway amidst difficult times. However, as Alan Riley notes, the Saudi economic buffer is relatively less strained due to its modest population [23]. However, with the spread of COVID-19, further economic strain is bound to be exerted on both countries. In fact, Saudi Arabia is already affected and is the only G20 nation to curb spending during the pandemic [24].
While dropping oil prices enhanced energy security for oil consumers like China and India, it spelt bad news for US’ shale industry. Initially though, President Donald Trump welcomed the price decline as low oil prices were viewed as a tax-cut on the public [25], a measure that potentially increases the president’s approval ratings. Further, these developments harmonized with his anti-OPEC policy, a position traditionally adopted by previous administrations. However, falling oil prices meant big trouble for the US shale industry for the following reasons. First, many shale companies carry a huge debt due to investments in fracking technology [26]. Secondly, shale oil’s production cost is one of the highest in the world, requiring oil prices around $50 to break even [27]. Third, lockdown measures across the US (where commuting constitutes half of vehicle miles on cars and light trucks [28]) led to a sharp decrease in the domestic oil demand.
Consequently, many shale companies struggled and US energy jobs became precarious [29]. Further, since most companies are based in the oleaginous ‘Red’ states of Texas, Ohio, and Pennsylvania, electoral prospects coerced President Trump to take action. On April 2nd, he urged MBS and Vladimir Putin to find a resolution to the imbroglio. In a separate conversation with MBS, President Trump is alleged to have suggested withdrawing US military support to Saudi Arabia if an agreement with Russia wasn’t reached [30]. This threat is observed as fundamental in expediting the process of the largest production cut in history. On April 9th, OPEC+ and its allies agreed to a 9.7 million bpd cut which would be implemented from 1st May for two months. This will progressively decrease to 7.7 million bpd for the next 6 months and 5.8 million bpd for the subsequent 16 months [31]. This agreement concluded the Oil Price War.
Finally, one must understand why this war was a single black swan event. First, the pandemic and the ensuing lockdown is erroneously identified as a black swan. Therefore, the current lockdown-induced demand shock was highly predictable. However, almost all national security and market analysts couldn’t portend a price war scenario between Russia and Saudi Arabia. To them, it seemed like a highly improbable event (due to the coronavirus) that wouldn’t be expedient for either Russia or Saudi Arabia. However, in retrospect, geopolitical inspirations do explain this event’s occurrence. Thus, the Oil Price War of 2020 is a single black swan event: Improbable in prospect, highly probable in retrospect.
Ramifications, Impact on Future Geopolitics and Renewable Energy
While President Trump celebrated his negotiation prowess on Twitter, many observers deem this ‘late’ measure as insufficient to arrest the demand slump. Pragmatically, supply cuts will have to play catch-up to demand as the pandemic further unravels. The global demand shortfall is estimated to fall between 20 to 30 million bpd, something that a 9.7 million bpd cut doesn’t sufficiently mitigate [32]. Further, the agreement doesn’t alleviate the crisis of the US shale industry which is evident in the data of the Federal Reserve Bank of Dallas collected between March 11-19 [33].
Since then, WTI prices have fallen well below $40 with futures for May contracts reaching negative prices on April 20. Thus, more shale companies might potentially declare bankruptcy towards 2021 as WTI prices will take some time to reach $40.
Further, there exist several geopolitical implications. First, the temporary alliance appears to be extremely fragile [34]. Close watchers of the event need to observe how this nascent alliance evolves. Further, the 75-year Saudi Arabia-US strategic partnership was fractured, but the US shale industry’s looming bankruptcy crisis promises to make it ‘anti-fragile’ in the short term. The crisis implies US’s increased reliance on Saudi Arabian oil as it attempts to engineer an economic recovery whilst concomitantly securing its energy security [35]. Conversely, an increased role of the US in the Middle East could transpire, given that its proxy’s (Saudi Arabia) fiscal situation is deteriorating. While contradictory to Trump’s minimalistic approach to the Middle East, the current economic scenario indicates this to be the most feasible measure. Moreover, decreased capital investments in oil markets might lead oil producing nations to rethink their FDI regulations. Cumulatively, these implications possess potential to alter the geopolitics of the global energy market.
Further, these implications have led some to believe that renewables might finally be cardinal to energy market. However, resource shifts in global energy market haven’t been very steady. While analysts at CarbonTracker acknowledge that the crisis might have bought forward fossil fuel’s peak demand by three years [36], the optimism seems transient. As Ferry highlights, the pandemic’s exacerbation of existing economic inequalities coupled with the non-linear relationship between economic growth and environmental attitudes is bound to make this transition harder [37] [38] . Further, the coincidence of cheap oil prices with economic recovery doesn’t help the case for renewables. Marginally, this could be mitigated by government policies, but it is hard to envisage most fiscally drained governments adopting such approaches. A case in point is the $60 billion (out of the $2 trillion US stimulus) for the US shale industry [39].
Nonetheless, the comprehension of economic motives behind such policy actions can strategize the renewable energy transition by devising better economic incentives for governments. This can help Oil’s Black Quarter to transform into a Renewable Green Quarter.
Tanay Katiyar is a senior at the School of Liberal Studies (SLS), Pandit Deendayal Petroleum University where he studies Economics with a minor in International Relations.
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