With attention pointed towards the effects of the Covid-19 pandemic on global health, the indirect consequences of the outbreak have attracted significantly less attention. An economic and geopolitical story which would ordinarily have garnered significant media attention has been unfolding amidst the coverage of the current crisis – a transnational dispute over the global economy’s most vital resource – oil.
From early January to the end of March, oil prices fell by more than 60 per cent from approximately $60 per barrel to nearly $20 per barrel. To put this dramatic slide into perspective, the last time that the price of oil collapsed to this extent unfolded over the course of 20 months between June 2014 and February 2016 – the recent fall of 68 per cent, on the other hand, took just two months.
However, while the coronavirus may have initiated the slide, with manufacturing and transport demands substantially reduced, the situation was worsened by a transnational geopolitical dispute over production that emerged between Saudi Arabia and Russia.
Since 2016, Russia and Saudi Arabia have had an agreement to collectively use their market power and influence to put a floor under oil prices by placing caps on production. With a reduction in global demand for oil stimulated by the coronavirus and a subsequent slide in price, Saudi Arabia looked to prevent further collapse and stabilise the price by requesting that production be capped at 1.5 billion barrels per day (bpd). However, Russia declined to agree to this proposal – maintaining output at pre-existing levels. In response, Saudi Arabia flooded the market with an extra 2.6 million barrels of crude oil per day as well as cut prices for consumers in Europe – a key market for Russia’s oil industry. This resulted in a 30 per cent fall in the price of oil in just one day – representing the largest one-day crash since the Gulf War in 1991.
Despite the dramatic reduction in price, Russia maintained its position in refusing to cap production – making clear that the stability and health of its economy is far less reliant on oil exports and hence could absorb the pressure of lower prices for an extended period of time. This appears, in theory, to be true. Although both Saudi Arabia and Russia have substantial foreign exchange reserves of $490 billion and $440 billion respectively, Riyadh need a price of $82 per barrel to balance their budgets while, according to the IMF, Moscow could balance their budgets with a price of $42 per barrel.
Yet, with the price of Brent crude falling as low as $20 per barrel in late March, it would appear that this is a particularly dangerous game for Russia to play, especially given that its central bank reported last year that the economy could be pushed into recession if the price of oil falls below $25 per barrel for a sustained period of time. This would be particularly unwelcome for President Putin who is looking to develop the economy, improve living standards and cement his leadership into the future.
As the situation escalated and the price fell further, there was little sign of the disagreement being resolved. Indeed, with the agreement over production expiring at the end of March, leaving everyone free to produce as much/little as they want, both parties moved to expand their production. Saudi Aramco, the Saudi Arabian oil company, announced that it would provide 12.3 million bpd of crude oil in April, which is two million bpd more than an estimate for March, while in Moscow, Russia’s energy minister Alexander Novak said that the country could increase production by 200,000 bpd – 300,000 bpd in the short term and 500,000 bpd in the longer term.
Given that there is little sign of the effects of the coronavirus abating in the short term, global demand is unlikely to be restored within two to three months and hence surplus production will continue to suppress prices. Yet, as with many geopolitical disputes, it would be too simplistic to assume that this oil-price war merely hinges on a breakdown in relations between two nations.
While it may appear to be a clash solely between Russia and Saudi Arabia, the row intimately involves the USA too. Assisted by the expansion of its shale industry, the United States has become the world’s largest producer of oil in the past decade, surpassing both Russia and Saudi Arabia in the process, and accounting for approximately 18 per cent of market share, as of November 2019. But price is important. If oil remains below $40 a barrel, some of the smaller US shale companies could be pushed out of business, thus affecting the United States’ position atop the global oil production rankings. Russia’s decision to maintain production and actively drive down the price puts pressure on the US shale industry who have been benefiting from the OPEC+ production caps as part of the aforementioned Russia-Saudi Arabia deal.
As such, rather than a simple two-party dispute, this has become a tripartite issue involving the three largest producers of, currently, the global economy’s most important resource. Over the course of the past week, the situation has developed further and muscled its way onto the news – on both sides of the Atlantic.
Last week, Saudi Arabia and Russia agreed that they were each ready to take certain measures, if necessary, to balance the market by cutting the combined output along with other OPEC+ members from May. Whether this will materialise remains to be seen but, perhaps the more dramatic headlines have emanated from the USA, as the price of a barrel of West Texas Intermediate (WTI) fell below zero for the first time in history on Monday. This fall in price was essentially the result of traders being unable to find buyers for futures contracts to be met in May and vividly illustrates that the global economy is currently suffering from a prolonged oversupply of oil.
Despite the agreed supply cuts, certainty over the future price of oil is still very much unknown. Any recovery in the price, coupled with the restoration of normality to the global economy following the coronavirus outbreak, will only paper over the cracks of what is clearly a fragile economic situation and complex geopolitical issue. This crisis has exposed the underlying tensions surrounding the most important resource in relation to the global economy as well as how fragile the relationships are that keep the oil market stable.
Position, authority and control in the energy markets is still critically important and, as the world’s reliance on oil reduces, with countries looking to switch to greener sources of energy, disputes over production and price, akin to what has occurred over recent months, could become ever more frequent.