How increased U.S. shale oil production, led to the breakdown in Russia-Saudi relations.
Saudi Arabia’s decision to launch a price war in oil markets earlier this month could not have been more poorly timed, coming amid plummeting global demand for oil due to the COVID-19 pandemic. The Saudi announcement sunk oil prices to an 18-year low, near $20 per barrel, after five years at more than double that price, putting further downward pressure on already troubled financial markets.
Saudi Arabia had gambled that by flooding the market and pushing down prices, it could punish Russia for refusing to cut its output, while recouping market share that had been ceded to U.S. shale oil producers. But the risky move could do lasting damage to the global economy, to oil-dependent countries and to Riyadh’s budding partnership with Moscow.
The price war is rooted in a sudden breakdown in cooperation between Saudi Arabia and Russia. The pair began to make common cause starting in late 2016, as U.S. shale oil was flooding the market and creating a supply glut. American oil production has doubled since 2009, rising above 12 million barrels per day last year to make the U.S. the world’s largest oil producer. That surge left Saudi Arabia and OPEC without its usual market power to constrain global oil production and boost prices—unless Russia, the world’s second-largest producer, joined their efforts.
How increased U.S. shale oil production. The Saudi-Russia partnership was thus a marriage of convenience, and an unusual one given that the two countries had been at odds throughout the Cold War, when Saudi Arabia was firmly in Washington’s anti-Soviet camp. But their diverging responses to the economic fallout of the COVID-19 pandemic upended their warming ties, at least for now.
In response to plummeting global demand for oil due to the virus, Saudi Arabia sought to cut oil production by 1.5 million barrels per day on top of preexisting cuts of 1.7 million. The total production cut of just over 3 million barrels would have reduced global oil supply by about 3 percent, helping to keep prices stable. But Russian representatives at an OPEC meeting in early March balked at further cuts and argued for maintaining current output until the coronavirus’s impact on travel was clearer. Saudi Arabia responded with an abrupt about-face, announcing it would open the taps and flood the market with a record 12.3 million barrels a day starting next month.
How increased U.S. shale oil production. Two personalities are reportedly driving the split between Saudi Arabia and Russia. On the Russian side, Igor Sechin, a strident nationalist who heads the state-owned oil giant Rosneft, was reportedly one of the main opponents to further cuts. Sechin and other Russian oil executives view the U.S. shale industry as a parasitic newcomer to oil markets. Each time OPEC has constrained its own oil production, American shale drillers have ramped up their output in response, diluting the effect of OPEC’s actions and capturing market share.
Since American oil production responds mainly to market signals and not government oversight, the Russians understood that any confrontation would have to come not through political pressure, but through the market, via the price of oil. Sechin’s argument was that additional OPEC cuts proposed by Saudi Arabia made no sense because they would extend a life preserver to a U.S. oil industry that was showing signs of financial weakness.
The primary factor that brought Saudi Arabia and Russia together is the same thing that currently threatens to tear them apart: U.S. shale.
On the Saudi side, Crown Prince Mohammed bin Salman, popularly known as MBS, was the key figure in launching the price war. The crown prince was said to have been driven partly by a desire to punish Russia for refusing to join in additional production cuts, and partly to respond to perceived diplomatic slights by the Kremlin. Of course, the Saudi strategy also sought to undermine U.S. shale producers, but in a far more aggressive way than Russia, which simply wanted to avoid additional cuts.
For now, there are only hints of further discussion between Saudi Arabia and Russia. If the impasse drags on, it could threaten broader diplomatic and commercial ties between the two countries. Russian President Vladimir Putin made his first visit to Saudi Arabia last fall, and Riyadh has pledged billions of dollars in new investments in Russia.
Ironically, the primary factor that brought the two big producers together is the same thing that currently threatens to tear them apart: U.S. shale. In addition to creating a rival source of oil that is undercutting market share and prices for OPEC and Russia, America’s newfound abundance of oil has fostered a sense in Washington that the country has less need for its traditional “oil for security” alliances with autocratic Gulf regimes like Saudi Arabia. Some argue that America could save billions of dollars by reducing its military presence in the Gulf.
But U.S. shale, which needs OPEC to keep prices above $50 per barrel in order to be profitable, is on shaky ground. Producers are issuing layoffs and cutting spending, and the Texas regulator that oversees the state’s oil industry, the Texas Railroad Commission, is even considering a production cut, something it hasn’t done since the 1970s. Without help from the U.S. government or from OPEC, some American shale producers are looking like candidates for bankruptcy.
The Saudi oil price war also has important implications inside the kingdom. Just days before the momentous announcement of increased output, Saudi authorities conducted mass arrests of members of the royal family and military officials perceived as un-supportive of MBS’ accession to the Saudi throne. The government said the arrests were based on alleged corruption, but the purge is widely viewed as a warning to rival members of the royal family or supporters in the Saudi military and wider public that dissent will not be tolerated, even when oil prices are down. The purge also clears some opponents from MBS’ path to succeed his father, King Salman, as the head of state.
But MBS knows well that oil price wars are blunt instruments. Plunging prices hurt all producers, including Saudi Arabia and its allies like Kuwait and the United Arab Emirates, which have been calling for a return to negotiations. As the price war drags on, it becomes a test of wills among producer countries, which must cut government spending to survive on reduced oil revenues.
The strongest are those with diversified economies and big reserves of hard currency. They are less dependent on oil revenues or have the cash to finance budgets temporarily beyond their means. By this measure, Russia is in a stronger position. Saudi Arabia has some $500 billion in currency reserves and needs oil prices to be at $80 per barrel for its current budget. Moscow has similar reserves, but its diversified economy and free-floating currency allow it to fully fund government spending with oil at just $40 per barrel.
Extraordinary times call for extraordinary measures. Last Friday, one of the three Texas Railroad Commissioners, Ryan Sitton, had a rare phone conversation with OPEC Secretary-General Mohammed Barkindo. Sitton said on Twitter that they “agreed that an international deal must get done to ensure economic stability,” and that he had been invited to address the next meeting of OPEC in June. With any luck, the price war will be called off before the world finds out which petro-state can withstand the most economic damage.
Jim Krane is the Wallace S. Wilson fellow for energy studies at Rice University’s Baker Institute in Houston. His most recent book is “Energy Kingdoms: Oil and Political Survival in the Persian Gulf.”
Information and Image have been shared from an Article by Jim Krane titled How increased U.S. shale oil production, published at World Politics Review, on March 23, 2020. Image Credit: Jacob Ford for Odessa American via AP Associated Press, 2020.