If you lay down any map, and try to find a region that is not close to some oil fields or that does not have immediate access to some sort of oil drilling facilities, you will be surprised by the very few countries you will come up with.
Oil has been the driving force of the West’s economic systems for decades; it is the reason the Middle East has become, if not the most, then certainly one of the most vital regions in the world at this very moment. Oil price changes signal the birth and ending of whole economic structures, signal the beginning of financial crises that quickly turn into political upheavals and symbolise the significance of such a resource for the progression of our developed world. For many, the moment that oil dominated the economic markets, globalization earned a strong foothold over our societies.
Oil turned the national political workings into schemes of international significance; it brought international players together, divided nations and resulted in some of the biggest military clashes the world has seen in the last century. It has righty been termed, therefore, the lifeblood of industrial nations.
One might think why a whole article has been devoted to what seems to be the importance of oil and the role it plays in the economy. At a time of so many political, social and financial crises, you may think, why have we brought the subject of oil under the microscope?
The reason is simple: the price war that has just started combines all three aforementioned types of crises and threatens to destabilize economic markets even further.
On March 9th, Saudi Arabia fired the first shots at a price war. Prices dropped by as much as a strong 30%, the first such crude fall since the 1990 Gulf War. Riyadh’s threat to discount its crude and increase oil output brought markets to a disarray that sees no end: the Bent crude, the international marker for oil, fell to as low as $31.02 a barrel on Monday and eventually settled at $32.64 on Thursday. What has been the worst week in the oil business for more than a decade, quickly turned into a political statement that few expected.
To understand the story, one should name the leading characters.
The Organization of the Petroleum Exporting Companies, OPEC, was formed in 1960 and has the primary aim of stabilizing the oil markets and preventing exactly what has happened at this stage: the escalation of price wars among its members and leading petroleum exporting countries. Some of its members, including Russia, Saudi Arabia, the United Arab Emirates and Iran, have frequently tried to sidestep the guidelines of the organization and become the leading oil producers. Yet the stabilization mechanisms of OPEC have always managed to contain, one way or another, the crises. This hasn’t been the case now, however.
For Riyadh, it all boils down to the current COVID-19 outbreak. The viral pandemic has brought markets into severe disarray and has damaged the financial world deeply. This made the OPEC members deliberate on an agreement on March 5th to engage in further production cuts to mitigate the short – term impact of the Coronavirus outbreak on oil demand. The members failed to reach a deal, which came to a great surprise to many. This, in turn, encouraged the Saudi Aramco to boost its daily oil production to 13 million barrels a day, a significant increase from the 12 million barrels produced before. The Saudi retaliation over the weekend was lightning – fast: they quickly offered significant discounts on their official selling prices (OSP) for April.
What has this resulted into? And what does this mean for short – term market balance?
Though no OPEC member government will officially declare it, with representatives running around holding banners and chanting nationalist slogans, we have entered the phase of an oil – price war. Economists have questioned the judgement of the current administrations in proceeding to such a move, given that no economy of the OPEC members is completely immune to price crashes. The Saudi King, the Russian President and the UAE Emir may, among others, have great ambitions as far as the development of their economies is concerned, yet petroleum production and exporting is a game that you don’t engage in on your own; it is only with cooperation that you will keep the market healthy, stable and growing.
At a time when the world is already faced with a short – term yet vividly felt demand shock, this sudden and unprecedented price war will quickly translate into a massive oversupply. Already, Saudi Arabia claimed it will boost its production capacity to 13 million barrels per day and the UAE’s National co., claimed that by April it will boost production to 4 million barrels per day, a sizeable increase from the approximately 2.8 barrels it produces today.
Price wars can turn vicious, nasty and severely damaging. In such a situation, producers try to produce as much as possible so as to ensure their market shares. Saudi Arabia seems to have already topped the leaderboard, with Russia following, after statements that the country’s petroleum companies were able to already increase production by 0.5 barrel a day.
The expected result is that, eventually, this large oversupply will lead to a sharp fall in oil prices, depending on the market backdrop and its response to the crisis. Before reaching this stage, however, the market first has to overcome the two highly uncertain bearish shocks on the demand and supply sides of the equation. Analysts have suggested that the international oil market may experience historically – low prices, as low as $30 per barrel, in an attempt to reaccelerate demand and absorb the shocks that the recent decisions led to.
One thing is for certain, however, and that is the following: we have reached a stalemate. The leading oil kings, Saudi Arabia’s Mohammad bin Salman and Russia’s Vladimir Putin, have individually claimed that their economies are more than able to sustain their markets, given that their breakeven points are very high when compared to the US or other OPEC members.
From a geopolitical standpoint, this crisis may also be seen as Russia’s attempt to challenge the US further. If it’s one of the motivations of the current Russian government to hurt the US shale sector, it would make more sense to maintain its oil prices just below the point where they would undermine shale production for an extended period. Though this may greatly benefit net importers from the euro area and China, it will pose risks to the US shale sector where companies may face serious challenges in overcoming the crisis, especially in the midst of the continuously growing pandemic.
As a concluding thought, it is fair for any reader to assume that this price war will name a winner and a loser. This isn’t the case, however. Frictions between petroleum exporting countries aren’t infrequent and the incidents that can lead to price wars are many, yet in the face of an actual crisis no winner and no loser is named; all oil – producing and exporting countries suffer equally.
This is due to the fact that, as any living organism, the composition of the petroleum exporting companies depends greatly upon all its members and their decision have a direct impact on its well-being, its physical condition and ultimately its future.
The recent crisis reminded the international community who the real leader is, who dominates the market and who decides how every single decision will evolve: it is none other than oil, the driving force of all financial and political actions. Oil dependence hasn’t weakened, and petroleum production is still one of the most profitable sections of the economies that have been blessed – or cursed – with oil within their designated borders. The evolution of this crisis depends on individual leader’s decisions, on their willingness to endure losses and their ability to engage in long – term planning to help propel their economies.
Image Source: https://unsplash.com/photos/7syIOxlLpfA
Originally published at Trai i Leoni (https://www.traileoni.it/2020/03/the-awakening-of-the-oil-kings/)