Oil Wars: Understanding the Saudi-Russia Game of Chicken

by Ali Bakeer

As the world scrambles to deal with the coronavirus pandemic, Saudi Arabia and Russia are locked in an oil war that has sharply decreased prices to their lowest in almost two decades. This has sent shockwaves through energy markets and has economic and geopolitical implications far beyond the two states.

 In 2017, OPEC+ countries (OPEC and non-OPEC members) adjusted the production of oil to balance the market and keep the prices within an acceptable margin. The deal later served as an undeclared alliance between Russia’s President Vladimir Putin and the Saudi Crown Prince Muhammad bin Salman. It helped both sides to improve their energy income and created a bond between the two men.

 Last December, OPEC+ states agreed to cut oil output by 1.7 million barrels per day (b/d) until the end of March 2020 to cope with the decline in global demand. Saudi Arabia voluntarily offered to cut an additional 400,000 b/d.

The deal worked well until the coronavirus left its mark on the oil market and global demand. In response, OPEC discussed deeper cuts in its extraordinary meeting on March 5. Saudi Arabia agreed to a further 1.5 million b/d cut. OPEC wanted non-OPEC countries to contribute with a 500,000 b/d; cut , however, Moscow refused and suggested that it would be willing to discuss an extension of the existing cuts. As a result, the agreement failed and Riyadh announced on March 10 that it would increase its oil production to 12.3 million b/d over the coming months.

Flooding the market with oil led to an unprecedented drop in price from around USD 50 at the beginning of March to less than USD 20 by the end, the lowest price in about  eighteen years. Neither Saudi Arabia nor Russia seems willing to retreat; each thinks that it is in a better position to bear the pain and achieve its goals.

 Saudi Arabia thinks that Russia will blink first, since Moscow is already under sanctions, has a quickly depreciating currency, and doesn’t enjoy the same flexibility as Riyadh in increasing oil production. At best, Russia can add a few hundred thousand b/d to its production capacity, while Saudi Arabia claims that it can add around two million b/d, helping it to partially compensate for the drop in prices.

 Moscow, on the other hand, believes that it is equipped to withstand the low oil prices for a longer time than Riyadh for two reasons. First, Russia has greater foreign currency reserves than Saudi Arabia, and second, Riyadh’s fiscal breakeven price is almost double that of Russia’s. Both make the desert oil kingdom more vulnerable to low oil prices.

 As a result, both Saudi Arabia and Russia are pumping their maximum to the market. If this oil war continues with more supply and less demand, we might reach a subzero-price scenario, which could happen if the world runs out of places to store excess oil. Although some hold that a sub-zero price is unrealistic, others argue that it is more realistic than one might think because producers may have to pay for someone to take the oil off their hands!

Most likely, the Saudi-Russia oil war will not continue for long. Until the two countries decide to end it, however, there will be consequences on many levels.

 The economic implications are mixed. The bad news is that it will complicate the already troubled global economy and the income of developing countries could fall to their lowest in more than two decades. The good news is that oil-consuming countries will have cheap oil, and this can help them mitigate the financial burdens they will face due to the coronavirus pandemic and the coming economic recession.

From a geopolitical standpoint, the oil war between Saudi Arabia and Russia can restrain the aggressive military adventures of these states and their allies. So far, the war in Yemen has cost Saudi Arabia around USD 100 billion. With the sharp drop in oil prices and the disrupted Muslim pilgrimages, Riyadh needs every penny to bear the economic consequences of the pandemic. A few days ago, Saudi Arabia invited Houthi militias to Riyadh for talks, demonstrating that it is looking for a way out of Yemen.

As for Russia, the low oil prices will impact its budget and further depreciate its currency. Putin’s priority is to stay in power until 2036, and this requires that he keep the economy in shape and spend more money inside the country. These factors could affect Moscow’s ability to project power abroad and even stop its military adventures, especially if they require money with no returns.

Ironically, allies of both Riyadh and Moscow are set to lose most from the oil war. The massive drop in oil price is severely damaging the shale oil industry in the U.S. If the oil war continues, it will also lead to a deep recession, seriously threatening Trump’s bid for re-election. The U.S. President is currently engaging with Saudi Arabia and Russia to convince them to agree on a truce. Meanwhile, Iran is in the eye of this crude war. If oil prices continues to drop as the pandemic spreads in Iran, it will be even harder for the regime to sell its small amount of exports with extra discounts or smuggle oil as it used to do. This would further constrain Iran’s ability to to fund its regional allies and proxies.

Whether or not Saudi Arabia and Russia reach a truce will depend on several variables, including what the U.S. is willing to offer. In an equation where all three major oil producers have to agree on a common ground, it is safe to assume that reaching a deal will not be that easy. Even if they manage to secure one soon, the huge drop in consumption due to the pandemic means it is highly unlikely that they will be able to bring the market to its pre-coronavirus state.

This piece was republished from The Fletcher Forum of World Affairs.