The Saudi Arabia-Russia oil war against U.S. oil producers

Two of Donald Trump’s favorite autocrat buddies, Mohammad Bin Salman Al Saud of Saudi Arabia and Vladimir Putin of Russia, have decided to engage in a price war over oil in an effort to capture market share in Asia, and to force American shale oil producers out of business to reduce American market share.

Nice friends you got there, Donny. They just threw your ass under the bus.

Over the past decade the U.S. has become the top oil producer in the world. It gave Washington more power over the energy market and future revenues for Riyadh and Moscow. Naturally, the Saudis and Russians, the world’s two largest oil exporters, weren’t pleased.

“Russia and Saudi Arabia stand to gain substantial market share by bankrupting the U.S. shale oil industry. And they know the U.S. producers do not have enough capital to withstand a large drawdown in crude prices.” Collapsing Crude Prices Will Bankrupt U.S. Shale Oil Stocks. When U.S. oil and gas stocks start going bankrupt, these two energy-producing rivals believe they stand to gain the most.

The LA Times reports on the back story of this price war. How Putin spurned the Saudis to start a war on America’s shale oil industry (excerpt):

For more than three years, President Vladimir Putin had kept Russia inside the OPEC+ coalition, allying with Saudi Arabia and the other members of the Organization of the Petroleum Exporting Countries to curb oil production and support prices. On top of helping Russia’s treasury — energy exports are the largest source of state revenue — the alliance brought foreign policy gains, creating a bond with Saudi Arabia’s new leader, Crown Prince Mohammed bin Salman.

But the OPEC+ deal also aided America’s shale industry, and Russia was increasingly angry with the Trump administration’s willingness to employ energy as a political and economic tool. It was especially irked by the United States’ use of sanctions to prevent the completion of a pipeline linking Siberia’s gas fields with Germany, a project known as Nord Stream 2. The White House has also targeted the Venezuelan business of Russia’s state oil producer Rosneft.

“The Kremlin has decided to sacrifice OPEC+ to stop U.S. shale producers and punish the U.S. for messing with Nord Stream 2,” said Alexander Dynkin, president of the Institute of World Economy and International Relations in Moscow, a state-run think tank. “Of course, to upset Saudi Arabia could be a risky thing, but this is Russia’s strategy at the moment — flexible geometry of interests.”

The OPEC+ deal had never been popular with many in the Russian oil industry, who resented having to hold back investments in new and potentially profitable projects. In particular, Igor Sechin, the powerful boss of Rosneft and a longtime Putin ally, lobbied against the curbs, according to people familiar with the matter, who asked not to be identified discussing private conversations.

The Kremlin was also disappointed the alliance with Riyadh hadn’t yielded major Saudi investments in Russia.

* * *

When the novel coronavirus started devastating Chinese economic activity in early February — cutting oil demand in Saudi Arabia’s biggest customer by 20% — Prince Abdulaziz tried to convince Alexander Novak that they should call an early OPEC+ meeting in response to cut back supply. Novak said no. The Saudi king and Putin spoke by phone ­­— it didn’t help.

As the virus spread and analysts forecast the worst year for oil demand since the global financial crisis, the Saudi camp was hopeful Moscow could be won round at the next scheduled OPEC meeting in early March. The Russians didn’t rule out deepening cuts but kept making the point that shale producers should be made to share the pain. Putin, who has been the final arbiter of Russia’s OPEC+ policy since the alliance started in 2016, met Russian oil producers and key ministers last Sunday.

As ministers gathered in Vienna last week, Saudi Arabia made a final effort to force Russia’s hand. It persuaded the core OPEC group to support a deep production cut of 1.5 million barrels a day, but made it contingent on Russia and the other OPEC+ countries joining in. Novak turned up last at the Vienna headquarters, where his nervous counterparts were waiting for him, and he refused to budge.

The crown prince even considered calling Putin on Friday, according to a person familiar with the situation. But Putin’s spokesman made clear to reporters he had no plans to get involved. As for the two countries’ oil ministers, there was no personal chemistry between them, according to a person in the room. They didn’t exchange a single smile, said another.

With every leak from the meeting the price of oil twitched, as traders slowly came to realize a deal was going to be impossible.

* * *

“Let’s see how American shale exploration feels under these conditions” said Rosneft spokesman Mikhail Leontiev.

But the decision to take on shale could backfire. Although many drillers in Texas and other shale regions look vulnerable, as they’re overly indebted and already battered by rock-bottom natural gas prices, significant declines in U.S. production may take time. The largest American oil companies, Exxon Mobil Corp. and Chevron Corp., now control many shale wells and have the balance sheets to withstand lower prices. Some smaller drillers may go out of business, but many will have bought financial hedges against the drop in crude.

In the short run, Russia is in a good position to withstand an oil price slump. The budget breaks even at a price of $42 a barrel and the finance ministry has squirreled away billions in a rainy-day fund. Nonetheless, the coronavirus’ effects on the global economy are still unclear and with millions more barrels poised to flood the market, Wall Street analysts are warning oil could tumble below recent lows of $26 a barrel.

In Saudi Arabia, where the government is almost entirely dependent on oil to fund government spending, the economic hit will be immediate. Prince Abdulaziz and his half-brother Crown Prince Mohammed will have every incentive to boost production to maximize revenue as prices fall.

“Prices will fall until either Moscow or Riyadh call off the endurance contest” or North American production is massively curtailed, said Bob McNally, president of Rapidan Energy Advisors and a former National Security Council staffer.

Alex Ward at Vox has an explainer, The Saudi Arabia-Russia oil war, explained:

A long-standing deal between Saudi Arabia and Russia — two of the world’s oil-producing powerhouses — fell through over the weekend, sending global markets into a spiral and dashing future economic prospects in the US.

And it has almost everything to do with the coronavirus — or, more specifically, the drop in Asia’s oil consumption that’s being driven by the coronavirus outbreak there.

Last week, members of the Organization of the Petroleum Exporting Countries (OPEC), a cartel of 15 countries of oil-producing nations, met at OPEC’s headquarters in Vienna to discuss what to do as the disease’s impact has lowered global demand for oil.

Russia is not part of the bloc, but Russian officials were invited to the meeting. That’s because three years ago Russia made a deal to coordinate its production levels with the group, in a pact known as OPEC+.

At last week’s meeting, Saudi Arabia, the cartel’s leader, suggested the participants collectively cut their oil production by about 1 million barrels per day, with Russia making the most dramatic cut of around 500,000 barrels a day. Doing so would keep oil prices higher, which would bring in more revenue for nations in the bloc whose economies are heavily dependent on crude exports.

Riyadh considered the move necessary as Asia, which is roiling from thousands of cases of coronavirus mainly in China and South Korea, no longer consumes as much energy as it did only a few months ago. China’s refineries, for example, cut their imports of foreign oil by about 20 percent last month. Lower demand leads to a drop in the commodity’s price, which thus hurts countries’ bottom lines.

The Russians, wary of such a move for weeks, opted against the plan. It’s still unclear exactly why that’s the case. Some say Russia wants prices to stay low to hurt the American shale oil industry or is gearing up to seize a bigger sliver of Asian and global oil demand for itself.

“The Russians are more worried about market share and think they’d do better competing with the Saudis rather than cooperating at this point,” says Emma Ashford, an expert on petrostates at the CATO Institute in Washington.

Saudi Arabia didn’t take too kindly to the Kremlin’s decision and responded by slashing its export prices over the weekend to start a price war with Russia. That brought the price per barrel down by about $11 to $35 a barrel — the biggest one-day drop since 1991.

The upshot of that decision is the Saudis have positioned themselves to snatch what’s left of Asian oil demand by having a cheaper product to sell, aided by very low production costs per barrel. But there’s a big downside: The price for oil is a global one. If the Saudis tank it, as they just have, it goes down pretty much everywhere.

Dwindling revenues mean global energy companies — including smaller shale-producing firms in Texas and the Dakotas — make less profit. That’s spooked markets around the world, with shares in Tokyo dropping 5 percent and a top index on Wall Street falling by 7 percent, forcing a trading stop shortly after open on Monday.

President Donald Trump is unhappy with the news, of course, as a growing economy and a strong stock market are some of his best cases for reelection in November. But he simultaneously seems happy that lower oil prices mean prices at the gas pump in the US will also go down, which could potentially strengthen his electoral chances.

Few can predict what will happen next, especially since it’s unclear what further effects the coronavirus may have on the global economy. What is clear, though, is that lower demand for oil and longer-term trends in the energy market have ruptured the tepid Saudi-Russia alliance for now — and the consequences will be felt everywhere, including in the United States.

“At this point, it’s every country for themselves,” Emily Meierding, a Naval Postgraduate School expert on international oil cooperation, told me.

* * *

[E]xperts are split on the real reason for why this happened. But two schools of thought — which aren’t mutually exclusive — have emerged.

The first is that Russia wants prices lowered — not propped up via its Saudi deal — to hurt the American shale industry. The immediate results seem promising, if that is the Kremlin’s true intention. Stocks for smaller to mid-size US shale companies are in free fall now, with the valuation for some dropping as much as 45 percent in recent days. This would also be a way for Russia to get back at the US for sanctioning its major energy company, Rosneft, for its deals with Venezuela last month.

And there are reports indicating the US shale market was at least part of the reason why Russia walked away from the OPEC plan, as Russian President Vladimir Putin seems to think that working together to keep oil prices high would only help America. Now Moscow needs a new way forward — and it doesn’t involve cooperating with the Saudis, it involves competing against both them and the US.

But some experts are skeptical this was Russia’s true or primary motivation. They told me if smaller US companies go bust during this time, bigger American firms like ExxonMobil will just buy their assets. There will be more consolidation — fewer companies in the shale oil industry, perhaps — but America’s production won’t go away. Russia’s play, then, would be doomed to fail.

Which leads to the second and more convincing theory: that Russia decided to make a play for more power in the global oil market. It couldn’t do that by agreeing once in a while to cut production with the Saudis. After all, Russian firms still make money if those companies export in even at a time of low prices. The profit margin will be thinner, but they’ll still gain customers and some revenue.

“It’s all about regaining market share,” says Meierding, and both countries are now in a price and production war.

The problem is that Russia’s play and the Saudi response may end up hurting them both. Shares in their national oil companies — Rosneft and Saudi Aramco, respectively — have already dropped. And unlike in 2015-2016 during which China bought up a lot of oil during a period of low prices, there aren’t really any buyers like that to pick up the slack right now, as demand is dropping worldwide, Ellen Wald, an oil market expert at the Atlantic Council think tank in Washington, told me.

That makes Russia’s decision likely an ill-advised one. It’s going to lose revenue in its bid to compete with America while not necessarily gaining strength in the energy marketplace. Saudi Arabia is hoping that lowering prices, which also hurts its own bottom line, will get Moscow to realize that and start cooperating again.

The question now, Wald says, is: “Who will blink first?”