US, WASHINGTON (ORDO NEWS) — In the analysis of the OPEC + group’s inability to reach a new consensus on further reductions in production during the negotiations on March 6, 2020, two broad topics dominate.
The first topic is an analysis of the origins of the disagreements between Saudi Arabia and Russia, which caused their quarrel. The second topic is the analysis of the consequences, and as part of this analysis, the winners in the current situation, experts usually name the consuming countries for which the cost of oil has decreased markedly.
Meanwhile, much less attention is paid to the third important topic, namely, possible ways to resolve this price conflict in the oil market.
While the first of these three topics has already been covered in some detail, the rest have not yet been examined in such detail, and this article is intended to fill this gap. The focus of this article will be an attempt to answer three key questions related to the second and third topics. First, is China really the main winner in this price war? Secondly, what is the pain threshold for the key participants in this war, in particular Russia and Saudi Arabia? Third, will market forces play a decisive role in putting an end to the price war in the oil market?
China as the main winner
Typically, lower prices benefit countries that import oil and adversely affect countries that export oil. For example, during the period of falling oil prices in 2014-2016, China, the world’s largest importer of oil, saved approximately $ 2.1 billion for every dollar price reduction.
That is, theoretically, if the world oil price is now an average of $ 30 instead of $ 60, China will be able to save about $ 300 million daily on oil imports, according to the forecasts of the US Energy Information Administration and Morgan Stanley agency regarding demand.
In addition, it is believed that lower oil prices stimulate consumer demand and economic growth. In this way, China is likely to be able to take advantage of lower oil prices, to meet its very significant needs for imported oil and restart economic activity in the country.
However, in this optimistic picture, it is necessary to pay attention to some nuances.
First, the recovery of China’s economy depends on demand in other countries. For example, China is a key supplier of intermediates for companies in the United States, Europe, Japan, and South Korea. About 20% of global trade in intermediate products for production originates in China – in 2002 this figure was only 4%.
The current suspension of production in the United States and Europe, as well as an increase in China’s number of imported cases of coronavirus infection, offset the projected benefits of lower world oil prices.
Secondly, lower oil prices could adversely affect those key sectors of the Chinese economy that are not dependent on foreign customers. Chinese oil giants, suffering from falling revenues, can reduce the costs of exploration and production of oil, which in turn will become an obstacle to the implementation of orders of the country’s leadership to improve energy security.
Third, the slowdown in the Chinese economy was preceded by an epidemic of coronavirus infection. Before China can fully enjoy the beneficial effects of lower oil prices, it needs to deal with a number of structural hurdles, including declining labor productivity and capital, as well as the fragility of the financial sector. In any case, the experience of Asian economic “tigers” indicates that more moderate growth rates are likely to become a new norm for China.
Finally, the main and obvious winners in the oil price war were oil traders and tanker owners rather than China. Based on the widening price gap in the case of oil bought now and delivered later, oil traders acquired huge reserves of oil on land and at sea for transactions that would bring them huge profits in the short term.
The owners of the tankers benefit greatly from the sharp increase in transportation tariffs, which was the result of a mass of competing bids from oil traders and Gulf producers who intend to flood the market with cheap oil. But even before the start of the price war, tanker owners already benefited from the lack of oil tankers resulting from the sanctions.
Pain threshold and margin of safety
Among the key producers and exporters of oil, there are no winners. The question is which of them is in the most vulnerable position and who will yield first. The opinions of experts regarding the pain threshold of the three main players – Russia, Saudi Arabia and the American shale industry – differ.
On the one hand, the attachment of the Saudi Arabian currency to the US dollar makes it less flexible than the Russian ruble, which is floating freely. The Russian budget, which is heavily dependent on oil exports, receives an additional 70 billion rubles for each ruble of depreciation against the US dollar, since expenses related to oil production are set mainly in rubles, and oil revenues come in dollars.
Saudi Arabia sells its oil to Europe at a price of $ 25-28 per barrel, but it will be difficult to compete with Russian oil, as Russia can boast of reliable distribution networks, faster deliveries and low cost of oil production. On the other hand, although with an average oil price of $ 35 per barrel in 2020, Saudi Arabia’s budget deficit of around 15% of GDP looks rather disappointing compared to a practically zero Russian budget deficit, more substantial foreign exchange reserves from Saudi Arabia will help it maintain deficit financing over at least five years.
In addition, Saudi Arabia has access to foreign financial markets, in contrast to that which has fallen under the sanctions of Russia, although in this case China may intervene and make a new proposal in the spirit of a “credit for oil”. Ultimately, in terms of economic and financial buffers, Russia and Saudi Arabia are on roughly equal terms, especially given that, as history has shown, this oil war is unlikely to last more than two years.
Meanwhile, in the socio-political aspect, Russia most likely has a more substantial margin of safety. In modern Russia, stability has an advantage over growth. The Russian elite understands that the systemic reforms needed to revive the economy could piss off key players within Russia, with the result that Kremlin control over Russian politics will weaken.
Despite the fact that the confidence of the people in Russian President Vladimir Putin has noticeably decreased, he will most likely remain in this position for the rest of his life. The mentality of the fortress under siege, characteristic of Russian culture, is likely to help Russia survive the negative consequences of falling oil prices.
Meanwhile, the political situation of the crown prince of Saudi Arabia, Mohammed bin Salman, looks less solid. Since the coronavirus infection pandemic has led to a sharp decline in foreign investment and a decline in the tourism sector, on which its reform program is based, the public in Saudi Arabia may well refuse to tolerate the effects of the oil war.
Moreover, approximately one fifth of Saudi Arabian citizens bought shares of the national oil company Saudi Aramco, the value of which fell by 11% compared to the price in December 2019.
As for American shale oil producers, companies operating outside the Perm basin and having the largest debt may simply not survive such a sharp decline in oil prices. Indeed, an average oil price of $ 235 per barrel in 2020 could result in a loss of production of more than 3 million barrels per day compared to the level of 2019.
However, shale oil producers have already demonstrated their effectiveness and strength. In 2019, they increased production, despite a significant decrease in the number of wells. As a result, the average price of shale oil, at which these companies will not incur losses, fell from $ 68 per barrel in 2015 to $ 46 today. Some of them will even be able to derive financial benefits through a hedging mechanism. International oil giants,
How to put an end to the price war in the oil market
At the heart of the price war in the oil market in 2020 are simultaneous shocks on the part of supply and demand. This makes the situation very unusual, but still not unprecedented. The key participants in this conflict have faced each other before, in 1985, when the decision of Saudi Arabia to increase production by five times led to a drop in oil prices to $ 10, which turned out to be an additional financial blow to the Soviet Union, which collapsed in 1991.
A specific feature of the current situation is the global scale and depth of the decline in demand amid expectations of a global recession: over the next few months, oil demand may decline by 10 million barrels per day.
There are three possible ways to end this price war. The first is the recovery in demand in China, which in 2019 accounted for three-quarters of the growth in oil demand, one-quarter of global growth and almost one-fifth of global GDP. However, as noted earlier, its role as an intermediate locomotive in global supply chains, as well as its own structural imperfections, prevents China from playing the role of a global locomotive.
Thus, a quick settlement based on a recovery in demand is highly unlikely.
Eliminating the oversupply of oil may be the second way to put an end to the price war in the oil market. However, manufacturers of the Persian Gulf countries and Russia have already announced their intentions to increase production volumes in order to regain market share lost as a result of reduced production under the OPEC + agreement.
In the United States, the purchase of oil produced in a country in order to replenish the US Department of Energy’s strategic oil reserves would be akin to a reduction in production. However, the purchase volume is only a weekly production volume. And the growth of global production will be too significant to be quickly neutralized.
All this makes the revision of the terms of the OPEC + agreement the most realistic way to put an end to the price war. Perhaps whether the parties return to negotiations in Vienna will depend on the United Arab Emirates and Oman. Using the Declaration on Strategic Partnership between Russia and the UAE, this Persian Gulf state tried to close the distance between the policies of Russia and the Persian Gulf countries regarding Syria and Libya.
For example, in December, Saudi Arabia turned to the UAE to convince Russia to agree to new production cuts. Oman can also use its mediation role in the region. Given that its public debt already exceeds the size of its sovereign wealth fund, Oman is in the weakest position and will not cope with a long period of low oil prices.
The UAE and Oman can draw strength from the conciliatory signals coming from Russia and Saudi Arabia, which nevertheless left the opportunity for some kind of agreement in the OPEC + format in the future. Concessions from the United States, which are reduced to sanctions against Iran and Venezuela under the pretext of the need to alleviate difficulties amid a pandemic, can bring a positive Russian response.
A United States promise to seriously consider selling the much-needed F-35 fighters to Saudi Arabia and the UAE could also serve as an incentive for a deal.
In the meantime, balancing on the brink, wounded pride and falling demand will continue to fuel the price war in the oil market in 2020.
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The article is written and prepared by our foreign editors from different countries around the world – material edited and published by Ordo News staff in our US newsroom press.