The blow came suddenly, but not entirely surprising: On Wednesday morning, Saudi Arabia announced that it would like to increase its oil production as quickly as possible by one million barrels a day. The price of oil fell suddenly by five percent to just over $ 30 – after having already recorded its biggest slump since the beginning of the Gulf War earlier this week.
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The news went down somewhat on Wednesday because half the world is concerned with the consequences of the corona pandemic. But the maneuver from Riyadh is likely to be the beginning of a fundamental structural change in the global oil market.
For the Saudi crown prince Mohammed bin Salman, the corona pandemic offers the perfect opportunity for a strategic maneuver: the mixed situation of general uncertainty and global economic destabilization puts him in a position of strength in which he can cause oil prices to plummet.
The central lever for this is Saudi Arabia’s so-called reserve capacity. The Kingdom is one of the few oil exporters that can significantly increase their production when needed. Almost all other nations always support at the limit or have only small, insignificant scope for improvement.
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Saudi Arabia’s reserve capacity is actually designed to secure global oil supplies when production slips in other exporting countries. For example, because of the civil war in Libya or because of an oil embargo against Iran.
Suddenly Saudi Arabia is using this reserve as a weapon against its worst competitors: the United States and Russia.
Attack with announcement
The Riyadh offensive was preceded by a dispute with the government in Moscow. Last week, the Opec oil cartel, whose most powerful representative is Saudi Arabia, negotiated with Russia, one of the three largest producing countries in the world, to support the global oil market in the face of the corona crisis. Because of the virus pandemic, global economic output is expected to decline. As a result, the global need for oil is reduced. This in turn depresses prices.
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Saudi Arabia wanted to ensure that Opec and Russia collectively cut their oil production in order to reduce the global oil supply – and to counteract the drop in prices.
It is better to produce a little less oil, but earn more from the extracted barrels – that was the well-known strategy. Opec and its partner Russia have been using them anyway for a good three years to curb the oversupply on the world oil market.
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The calculation no longer worked out last week. Several countries refused to cut funding even further. Russia in particular blocked itself.
The bottom line was that the cuts in funding in recent years had above all strengthened the United States, the Russians argued. Their companies would use the controversial fracking method to extract more and more oil from shale rock and win ever larger shares on the world market. According to the “Financial Times”, the Russians not only questioned the unpleasant funding cut pact. They also threatened to increase their funding.
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Now Saudi Arabia apparently got ahead of the Russians on this point. And the price war on the oil market escalates.
Oil price of $ 20 possible
In Russia and Saudi Arabia, the production costs of some oil fields are less than ten dollars. The US fracking industry, on the other hand, has comparatively high production costs: According to analysts, the extraction of a 159 liter barrel of oil costs between 50 and 70 dollars. Some companies also have problems finding investors. So the fall in oil prices hits the US fracking industry at an inappropriate time.
Saudi Arabia is trying to restructure the world oil market, said Damien Courvalin, chief energy analyst at US bank Goldman Sachs, CNBC TV. He believes that the oil price will remain at $ 30 for several months, possibly falling as low as $ 20 – unless the Russians buckle and cut their production.
If not, a endurance competition would start. Both Russia and Saudi Arabia are economically heavily dependent on the income from their oil exports:
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According to estimates by the World Monetary Fund, the Russian government needs an oil price of around $ 45 to cover its household costs.
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The Saudi Arabian government even needs a price of around $ 85.
Both countries have capital reserves, so they can hold the price low for a while. The question is who has the staying power. In fiscal policy terms, Saudi Arabia hurts every cheap barrel sold more than Russia; the kingdom is now exporting significantly more oil due to the increased production.
Russia, however, is suffering not only from the low oil price, but also from the fall in the ruble. In January there were 68 rubles for one euro at the exchange offices, currently there are more than 80 rubles.
In any case, the US fracking industry is likely to be the big loser in this global economic chess game. Should bin Salman’s calculations work, US oil exports would drop noticeably soon and Saudi Arabia’s market shares would increase.
Geopolitical risk
Politically, however, this is not a good signal. The Middle East region is likely to be destabilized even more by a longer-lasting price low than is already the case.
States like Iraq, Iran or the United Arab Emirates are also dependent on income from oil exports and are now coming under pressure.
In other developing countries such as Angola or Venezuela, the already high political problems could be exacerbated by the low oil price.
Saudi Arabia is serving the already shaken world economy with its combat price strategy. According to calculations by the International Monetary Fund (IMF), a falling oil price releases capital on the bottom line because it tends to strengthen consumption. If the price drops by ten percent, the global economy will grow by 0.2 percent more, is the IMF’s rule of thumb.
It remains to be seen whether it will also apply in the current corona crisis, in which consumers are rather unsettled. The bottom line, however, is that the low oil price is likely to benefit the global economy. It is a risk factor for geopolitical stability.
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