The Oil Price War of 2020: Winners, Losers and Ways Forward
(Russia Matters – russiamatters.org – Li-Chen Sim – March 25, 2020)
Li-Chen Sim, an assistant professor at Zayed University in the United Arab Emirates, is an expert on the political economy of energy in Russia and in the Middle East.
Two broad themes have dominated analyses about the failure of OPEC+ to arrive at a new consensus on oil production cuts on March 6, 2020. The first explores the sources of disagreement between Saudi Arabia and Russia that informed the split. The second examines the fallout, with consuming countries typically assumed to be the winners of the situation thanks to lower oil import bills. Much less explored is a third theme, namely, the paths toward a resolution of the oil price war. While the first theme has already been well explored, the other two have not and this article will seek to fill this gap. In particular, it will focus on answering three key questions related to these two themes. First, is China the major beneficiary of the oil price war? Second, what is the pain threshold of the key protagonists, such as Russia and Saudi Arabia? Finally, will market forces play a decisive role in ending the oil price war?
China as the Major Beneficiary
Third, China’s economic slowdown pre-dated the outbreak of coronavirus. Structural impediments, including the declining productivity of labor and capital and the fragility of the financial sector, need to be adequately addressed before China can reap the full benefits of lower oil prices. In any case, the experience of Asian Tiger economies suggests a more moderate rate of growth could be the new norm for China.
Finally, oil traders and tanker owners, more so than China, are the outright beneficiaries of the oil price war. On the assumption of a widening price difference between crude bought now but delivered later, oil traders have secured storage facilities on land and at sea for transactions that will result in enormous short-term profits. Tanker owners have seen charter rates skyrocket as a result of competing bookings by oil traders and by Gulf producers intent on flooding the market with cheap crude. However, even before the oil price war, tanker owners were already profiting from the squeeze on the availability of oil tankers due to U.S. sanctions against tanker subsidiaries of China’s Costco.
Pain and Resilience
There are no winners among key oil producers and exporters. The question here is who is worse off and will be first to fold. Experts are divided on the pain threshold of the three main players: Russia, Saudi Arabia and U.S. shale companies.
On the one hand, Saudi Arabia’s currency peg to the U.S. dollar gives it less flexibility than the freely-floating ruble. Russia’s oil-dependent budget gets an extra 70 billion rubles for every 1 ruble decline against the dollar, since oil-related expenditures are mostly priced in rubles but oil revenues are earned in dollars. Saudi Arabia is selling oil to Europe at $25-28 per barrel, but Russia’s well-established distribution networks, quicker delivery times and $4 per barrel lifting costs could be difficult to overcome. On the other hand, even though Saudi Arabia’s fiscal deficit of 15 percent of GDP compares unfavorably to Russia’s near zero with crude at $35 in 2020, the former’s larger foreign cash reserves can sustain deficit financing for at least five years. It can also access foreign debt markets unlike sanctions-hit Russia, although China could step in with a new loans-for-oil offer. Ultimately, Russia and Saudi Arabia seem to be on par in terms of economic and financial buffers, particularly since history suggests this oil price war is unlikely to last more than two years.
Ending the Oil Price War
The oil price war of 2020 is underpinned by simultaneous shocks in demand and supply. This makes it highly unusual but not unprecedented. The key protagonists have also squared off before, in 1985, when Saudi Arabia’s decision to increase production five-fold caused oil prices to plummet to $10, puting additional financial stress on the Soviet Union, which collapsed in 1991. What is different now is the global scale and depth of the fall in demand amidst worries of a worldwide recession; oil demand could be reduced by 10 million barrels per day in the next few months.
There are three possible ways the oil price war can end. The first is demand recovery, especially in China, which accounted for three-quarters of oil demand growth in 2019, one-quarter of total global growth and almost one-fifth of global GDP. As noted earlier, however, China’s role as a locomotive is tempered by its intermediary role in global supply chains and its own structural shortcomings. A quick fix based on demand recovery is therefore highly unlikely.
Eliminating the oil supply overhang would be the other way to end the oil price war. However, Gulf oil producers and Russia have announced intentions to increase oil supply to win back market share lost during the OPEC+ production curbs. In the U.S., the likely purchase of domestically-produced crude to fill the U.S. Energy Department’s Strategic Petroleum Reserves is akin to a production cut. However, the volume amounts to only a week’s worth of oil production. The global supply surplus appears to be too large at this point to absorb expeditiously.
In the meantime, brinksmanship, bruised egos and battered demand will continue to inform the oil price war of 2020.
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