Why Saudi Arabia May Be Forced To Start Another Oil Price War

Yves here. The notion that weak oil prices through early 2021 would spark another price war suggests that the major actors, unlike stock market investors, also anticipate that a recovery will be sluggish.

By Dr. Cyril Widdershoven, a long-time observer of the global energy market. Presently, he holds several advisory positions with international think tanks in the Middle East and energy sectors in the Netherlands, the United Kingdom, and the United States. Originally published at OilPrice

The ongoing weakness of global oil markets seems to be stoking tensions within OPEC+, and a split within its leadership is now imminent. From the start of this year’s Moscow-Riyadh brokered OPEC+ production cut deal, internal differences have been kept at bay by a global pandemic and high crude oil storage volume. Market optimism now seems to be growing, from bullish reports about next year’s crude oil prices and even today’s IEA World Energy 2020 Report. But the reality of oil markets is far bleaker. The threat of European lockdowns is real, hitting global demand again while taking a heavy toll on the economy. Financial easing and subsidies worldwide have kept some demand in place, but the financials of major economies are bleak, which can be seen in the rising level of unemployment. This will not only remove OECD demand for oil but also for Asian manufacturing. OPEC+ seems to be looking at things differently though, with oil taps in Saudi Arabia, Russia, and other OPEC+ member countries opening once again. OPEC production cuts compliance is still around 100%, but the coming months will see that figure fall.

Nobody is speaking about a new oil price war yet, but the writing is on the wall with some producers now fed up with strangling their own production to counter the overproduction of others. Asian importers, especially China and India, have been reaping the rewards of this low price environment, filling their oil storage tanks to the brim. Although most Asian importers now seem to be content with storage. An OECD economic downturn will put several million barrels per day of expected Asian demand at risk.

In contrast to former assessments, Q32020-Q12021 is not forecast to see a healthy upturn of oil and petroleum products demand worldwide. Global oil storage levels are still high, while the world is awash with oil and gas. International traders are openly questioning the current OPEC+ move to put extra oil on the market, as there is no current need for these barrels. In January 2021, the former production cut of around 10 million bpd (May 2020) will fall to 6 million bpd. As stated in May, not even the existing cuts are sufficient and an easing of cuts will only prolong the current weak market conditions.

lIt is a worrying time for the two main architects of the OPEC+ agreement. One could say that Riyadh and Moscow are caught in a Catch22 situation, as whatever they try to do, the market is likely too weak to react and will come back to hurt both parties. Saudi Arabia, supported by its main ally UAE, and Russia are both looking at a financial crash of unknown magnitude if oil markets don’t recover soon. Oil prices are currently too low to sustain the government strategy of both nations. The latest reports on the Saudi government budget, which is based on a $50 per barrel scenario, is realistically too optimistic, as prices right now are in the low $40s. For Russia, its economy has been hit from all sides, as oil and gas is weak, demand worldwide is down, and the diversification of its economy is stalling. Putin’s maneuverability, however, is higher than that of the Saudi rulers. Russia’s global power position still opens doors to make life bearable in the coming months.

Saudi Arabia, however, is looking at a situation in which a straightforward strategy does not seem to exist. Without higher crude oil prices, not only is the Kingdom’s flagship Saudi Aramco suffering but most government projects too. The world’s largest oil company has already put several major new projects on hold, while at the same time reassessing investment levels of others. High-profile offshore projects, such as the Red Sea or the setup of the new shipyard in Ras Al Khair, are not progressing as fast anymore, showing some internal constraints.

Aramco is also being squeezed by Riyadh for cash to fund the ongoing Saudi Vision 2030 projects. Diversification of the economy is needed, but without cash, projects are being delayed or even put on ice. The Kingdom’s finances are struggling, already shown by the fact that international interest for Saudi (and Russian) government bonds is waning. Last week’s US$ -denominated government bonds to Russia and Saudi Arabia have fallen, mainly due to lower oil prices and U.S. election issues. If capital markets are getting worried, then Riyadh and Moscow really are in trouble. Drastic measures will need to be taken.

With an internal crisis looming, the Bear and the Kingdom could be forced to take totally different roads. If the threats made by Saudi Arabia’s Minister of Energy Prince Abdulaziz Bin Salman that the Kingdom has had enough of profit takers, short investors, or lack of support of members, are to be taken face value, the market should not be surprised if the OPEC leader decides again to go its own way. A more aggressive move by Riyadh towards market-share or oil prices is not at all unthinkable. The ongoing financial onslaught wreaking havoc on IOCs and oilfield services is also hitting NOCs. Revenues and profits are still high, but their respective governments are in dire need of cash. The relationship between Russia and Saudi Arabia may have appeared to be a marriage made in heaven, but now it is all falling apart.

With internal financial pressures and increased unemployment, especially amongst young people, young leaders in the Middle East are likely to follow their hearts. If cooperation will not bring the necessary rewards, the old option of a new oil price war is not unimaginable. The global energy transition and fossil fuel divestments are already removing the weak for the oil and gas industry. There is a need for consolidation, maybe Russia and Saudi Arabia will follow a Malthusian-Darwinian approach in the future. This time, both IOCs-independents and some weaker OPEC+ producers will suffer. Statements made these weeks that Saudi Arabia wants to be the last oil producer standing or the “Sole Survivor” should not be taken lightly. This implicit threat needs to be taken at face value. The gloves are likely to come off in the coming months, and oil markets will have to be ready.

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22 comments

  1. Rod

    Perfect time for SA to Decommission and Realign Petroleum—in line w their 2030 Plan(maybe 2028).
    But for that Dollar(US).
    Anything breaking or disrupting the stranglehold of Oil and it’s Profiteers and their SOPs is an opportunity to juke a move for a Future, imo.

    Reply
  2. Matthew G. Saroff

    Another reason why Russia has a stronger hand: An increasingly robust agriculture sector, particularly with regard to staples.

    They can feed themselves if their currency crashes.

    Reply
    1. drumlin woodchuckles

      And the fact that Russia built up its food sector behind the defacto protection of outside-imposed Sanctions which had the effect of protectionizing Russia’s ag sector . . . goes to show that Protectionism works.

      Free Trade destroyed what Protectionism built. And Protectionism can rebuild what Free Trade destroyed, and what Free Trade continues to destroy every single day.

      Reply
      1. Matthew G. Saroff

        Free trade is a bad term to use.

        These deals are all about choosing winners and losers, not truly free trade.

        Dean Baker is a good source on this.

        Reply
        1. drumlin woodchuckles

          Free Trade is what the IFTC ( International Free Trade Conspiracy) calls it. So I will keep calling it Free Trade. I will not lose myself in the weeds of brilliantly intellectual parsing of words and meanings.

          I could call it Forcey Free-Trade. That’s another occasional good name to use.

          These deals are about preventing National Governments from being able to regulate trade across their own borders for National Sovereign reasons. So Free Trade remains a good name for other than just simplicity reasons.

          ” Free Trade is the New Slavery.
          Protectionism is the New Abolition.”

          See how beautifully formed that slogan is when the word ” Free Trade ” is used? Another good reason to keep the word ” Free Trade”.

          Reply
  3. Synoia

    “Nobody is speaking about a new oil price war yet, but the writing is on the wall with some producers now fed up with strangling their own production to counter the overproduction of others.”

    The Author is. That’s more than nobody.

    “Asian importers, especially China and India, have been reaping the rewards of this low price environment, filling their oil storage tanks to the brim.

    How is that relevant? Most petroleum storage has a maximum of one to two month of supply.

    It is a cycle. In the next year few years there will be a shortage, because supply and demand are cyclical.

    Lack of production investment now has its price rewards some years in the future.

    Reply
  4. Susan the other

    This is interesting. I sorta thought that was what was happening the last time KSA undersold everybody. They don’t wanna be left with stranded assets; they’d rather sell em cheap. And they do have the best grade oil and the easiest access of any other producer. The horizon for oil is much shorter now. It also makes sense that Russia was so friendly with the Saudis. They were trying to make deals to prolong their own oil industry. The Russians have done direct pipelines to northern EU (natgas) and to China – they have stayed to the north. Whereas KSA has made deals to do a pipeline to Israel (?) it appears. Is that one natgas? I’m wondering where Iranian oil/Caspian oil is going. Looks like every oil baron for himself now. We’ll see who lasts. Most statistics say we still use oil for some 90% of our energy needs. The Chinese can’t build their railroad from Yunnan to the Gulf of Thailand without oil. Nor the rest of the dams planned for the Mekong – big projects. Maybe the use of oil will last for some time but be restricted to big projects. And green projects. The worst pollution from petroleum comes from cars and consumer uses. And probably the military as well. But we can’t exactly just quit using it.

    Reply
    1. a different chris

      >And they do have the best grade oil and the easiest access of any other producer.

      It will be interesting to see how that plays out. I don’t want to use a car analogy because immediately everybody will think I’m talking about gasoline, but I’m not. It unfortunately just has the perfect fit, as you need them mostly especially in America, and they cost quite a bit.

      So you look at a Chevy (30K) and a Mercedes (50K) and by far most of us buy the Chevy. But what if the prices were cut by a factor of 5? Now a Chevy is 6K and a Mercedes is 10K. A lot more people buy the Merc, maybe even a majority.

      So SA is in, well not a good position (cue the fainting in Stuttgart at $10K cars), but it may be the best of a lot of bad positions going forward.

      Reply
  5. j cazador

    The economy of Russia is underestimated/under reported in this little article.
    E.g., no mention here of the impending completion of nord stream 2, over the serious opposition of USA. E.g., no mention of Russian’s enormous gold holdings, and its independence from USA dollar.
    Highly recommended:
    https://patrickarmstrong.ca/

    Reply
    1. Gregory Bott

      Independence from the US dollar just isolates you and impoverishes your country without “allies” to build your currency into. Maybe they are finding out financing “right wing anti-American globalists” isn’t getting the job done. Maybe time to go back to old ways and ignite a far left revival that basically wants to destroy capitalism at all costs?

      The pro-dollar vs anti-dollar war isn’t ending anytime soon, but phase one was a bust in many respects and Trump was a anti-Clinton driven fluke.

      Reply
      1. jo6pac

        Russia has friends one is China and I’m sure they are both moving away from the dollar. They trade now in their on currency along with a few others. Russia holds almost 0 US bonds and dollar in their reserves.

        Reply
        1. Ashburn

          I agree the reign of the US dollar may be ending. Trump and Pompeo have weaponized the dollar to force sanctions not just on the usual suspects but even on the third parties that trade with them. China and Russia have good reasons to seek a new medium for international trade. Block-chain technology and crypto currencies may be the key to undermining the “exhorbitant privilege“ the US has enjoyed for decades.

          Reply
  6. j cazador

    quote
    In a 2019 research report to the US Army, the RAND corporation published a set of policy recommendations under the title, “Extending Russia: Competing from Advantageous Ground.” They note that by extending Russia they mean “nonviolent measures that could stress Russia’s military or economy or the regime’s political standing at home and abroad.” All of the above stress points certainly fill that description. More striking is the specific elaboration of possible stress points to “extend Russia,” that is to over-extend her.

    The report specifically discusses what they call “Geopolitical Measures” to over-extend Russia. These include providing lethal aid to Ukraine; promoting regime change in Belarus; exploiting tensions in the South Caucasus; reduce Russian influence in Central Asia. It also includes proposals to weaken the Russian economy by challenging its gas and oil sectors.

    F. William Engdahl
    https://journal-neo.org/2020/10/13/rand-and-the-malevolent-encirclement-of-russia/

    Reply
    1. rkka

      “In a 2019 research report to the US Army, the RAND corporation published a set of policy recommendations under the title, “Extending Russia: Competing from Advantageous Ground.” They note that by extending Russia they mean “nonviolent measures that could stress Russia’s military or economy or the regime’s political standing at home and abroad.” All of the above stress points certainly fill that description. More striking is the specific elaboration of possible stress points to “extend Russia,” that is to over-extend her.

      The report specifically discusses what they call “Geopolitical Measures” to over-extend Russia. These include providing lethal aid to Ukraine; promoting regime change in Belarus; exploiting tensions in the South Caucasus; reduce Russian influence in Central Asia. It also includes proposals to weaken the Russian economy by challenging its gas and oil sectors.”

      Yes, the US tried that, with fracking shale oil. There was a small problem though. Russian oil companies are profitable at around $25/bbl. The state taxes away nearly all the windfall above that. However, US shale frackers only kept current on their operating costs and interest payments, even at $100/bbl. With the collapse, tens of billion$ in investor cash is spontaneously combusting as shale companies go bankrupt, being unable to pay back principle.

      So as it has turned out, RAND’s recommended measure to impose costs on Russia imposed bigger costs on the US.

      Reply
  7. John k

    Fracked oil has always been a loser, now more than ever. This is 2/3 of us oil production, and nearly every barrel could stop at 40/bbl, imagine 30, or further south. Investors are tired of pouring money in, banks are moving to foreclose on debt and run the companies themselves. But IMO at 30 they lose money even with no debt. So a price war, moves forward the time when these wells get capped in the hope of a better future someday.
    And that’s Saudi, and maybe Russian, hope; knock off 7 mil bbl/day of us production means more sales for them, given their far lower production cost, especially Saudi, sub $10/bbl.
    And that means we once again become dependent on oil imports, but now 7 mil bbl/day, say $200 mil/day, $70 bil/yr.
    Saudi can’t produce enough to drive everybody else out, but they can remove the high cost producers… that’s when a country stops producing, they don’t really run out, but their remaining oil costs too much to produce.

    huge number of formerly well paid workers go on unemployment, already started.
    We will be stressed along with many others.

    Covid is moving forward the transition to renewables. Renewable generation and storage costs continue dropping fast, the bottom not yet in sight. Large amounts now going into research, private not gov. Waves of e cars finally coming, especially vw… oddly, Japanese seem to be missing the memo.

    Reply
    1. j cazador

      “Covid is moving forward the transition to renewables.”
      Sorry, but that does not make sense to me.
      Covid is reducing the demand for oil, thereby reducing the price against which renewables are forced to compete.

      Reply
      1. Gregory Bott

        Yeah, but renewables even at this price compete well with oil. They need real prices at 1998 levels to put a dent into it.

        Reply
  8. drumlin woodchuckles

    Various national countrygovs may want one thing while the inhabitants of those countries want something else.

    The DC FedRegime would like oil to stay just expensive enough that its allies and servants may continue making money from oil. And if oil is somehow important in backing some of the dollars in the world, then the DC FedRegime may want oil to stay valuable to keep backing those petrodollars.

    But American citizens can want something else, if they want to. How many American citizens are “blue”? Or “green”? Or “blue-green”? The blues, greens and bluegreens might all want to see the oil industry go extinct. Could chaotic price wars help that happen by destroying the oil sector in some countries, leaving other countries to keep pumping oil, and then raise the price when they see an opportunity? What if they raise it enough to lower purchasing of it by consumers?

    What if a global blue-green petroconsumption slowdown could foster chaos in the oil markets and destroy some country oil industries and tempt petro-survivor countries to raise prices enough to destroy demand for THEIR oil? Would a billion bluegreen semi-boycotters all over the world be able to sow and spread petro-destructive chaos in the oil industry and its countries?

    Reply
    1. drumlin woodchuckles

      Good. That just makes this an even finer situation for a billion bluegreen people all over the rich and semi-rich world to re-adjust their lifestyles downward as deeply as they can accept for the rest of their lives and grind their down-shifted lifestyles as far away from oil as possible.

      KSA will just keep price-chasing the falling demand down and down and down. Eventually KSA will be the only country able to sell oil at the least bit over cost of production. That is the time for the world to deplete and destroy the KSA oilfields as totally as possible, leaving the KSA with no oil and no money and no more threat it can pose to a tortured world.

      Reply
  9. rjs

    OPEC’s monthly report, out on Tuesday, had all the members in compliance with the prescribed cuts for the first time in my memory (i’ve covered that report for years)

    Reply

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