Oil is dead. The oil price is diving into the single digits. These two statements were tweeted out from the King of Crude, Gary Ross. We are in a period of historic demand destruction, unprecedented in its depth and speed. In just three months, oil demand has declined by millions of barrels a day, a loss of 10.5 million barrels a day (mbd) in March alone.
Analysts expect it to go deeper, with some estimates calling the free fall to be between 18 and 20 mbd, maybe more. With more than half of the world shut down, there’s nothing supporting demand. There is significant uncertainty around if and when we will see demand rebound.
Understanding demand destruction and the price collapse is about the global ramifications of COVID-19 and resulting global lockdown. More than a million Indians are on lockdown for almost three weeks, and much of the United States remains closed for business. As if the global pandemic weren’t enough, there’s an oil price war involving Saudi Arabia, Russia and the United States, and each player has a different narrative for who is responsible.
Three weeks ago, Saudi Arabia made the 360-degree decision reversal to flood the market with more oil during a period of diminishing demand. The kingdom went into the OPEC+ talks on March 5 intending to cut production, offering up the number of 1.5 mbd, from the already agreed upon earlier production cuts of 1.7. Russia didn’t budge, and the meeting failed; no deal. Within 48 hours of the OPEC + meeting, Saudi Arabia turned the tables and with it the story. This was not just about how COVID-19 was ravaging demand but also about Saudi Arabia making a retaliatory move to pump more oil and raise its production from 10.1 to 12.3 for April deliveries while also slashing prices for its product.
Production increases layered on top of historic global demand destruction resulted in a freefall for oil prices, losing over 60 percent, and this week Brent is already trending lower, with U.S. oil falling below $20 a barrel.
Russia’s decision not to participate in a production decline was intended to punish U.S. shale. Russia hoped that a deepening price decline would push shale producers, already knee-deep in debt, closer to the grave. Russia needed to retaliate against the U.S. for the layering of new sanctions, especially the most recent to hit Rosneft for trading in Venezuelan oil.
But there’s another story to be told. Maybe Saudi Arabia got tired of all the back and forth negotiations, whether with the other members of OPEC or with the NOPEC members, first and foremost, Russia. Saudi Arabia launched a price attack against OPEC+. There are only a few members – Saudi Arabia, the United Arab Emirates and Kuwait – that can withstand a long period of price destruction. All of the above have insurance policies through their sovereign wealth funds and easier access to credit. The other OPEC members, many politically and economically fragile going into the COVID-19 demand downturn and recent Saudi maneuvering, are now on the brink of profound economic hardship and political instability. Saudi Arabia waged a price war not only with Russia but also with members of the cartel. This move represents Saudi’s decision to go it alone; unilateralism is Saudi Arabia’s new oil strategy. It’s energy authoritarianism that weakens OPEC.
Saudi Arabia sees the writing on the wall.
Oil’s lifeline is shortening, whether it be through new climate change policies and renewables taking the place of fossil fuels or the reckoning that oil demand has peaked. Getting oil out of the ground while they can is the best strategy for many decisionmakers in the kingdom, even if it challenges economic orthodoxy in the short term. Bernard Haykel, professor of Middle Eastern Studies at Princeton, recently wrote about Saudi Arabia’s radical new energy strategy, supporting the narrative that its recent decisions are more about hedging for a more decarbonized future. If his analysis proves correct, we can expect to see Saudi Arabia continue to pump regardless of where the price goes.
The losers in this new battleground are other members of OPEC. Inequality exists across OPEC. Iraq, Iran, Venezuela, Nigeria and Angola, are not resilient to current price realities. Non-oil revenues are unreliable due to a lack of economic diversification, which has been decades in the making. Kuwait and UEA sit on financial assets and have a lifeline in managing today’s combination of shocks. Others are fragile and moving towards failed state status.
Saudi Arabia has unleashed unprecedented pain across OPEC, exposing members’ vulnerabilities. The absence of resiliency due to over-reliance on oil revenues while also having high fiscal deficits is a problem many within OPEC confront, and it’s just gotten worse. Deepening instability is inevitable. Only a few months ago, protests shook Iraq and Iran, and Venezuela has been on Russian and Chinese life support for years. These countries may see their oil stranded, already much of the world’s oil is proving uneconomic to produce under current price levels.
Saudi Arabia, with Crown Prince Mohammad bin Salman at the helm, may offer a white flag and agree to cut back on its production upsurge. Or maybe Russia will hear Trump out and return to negotiations with Saudi Arabia. A production cut by Aramco will do little at this point to change prices. If the forecasts prove correct and there’s a 20 mbd or more significant loss of demand, it would equal Saudi Arabia and Russia’s production combined. There’s just too much oil out there, even with production cuts, to achieve any level of price stability.
The kingdom’s longer-term strategy is to get its oil out of the ground, even if it means challenging some of its own economic and social policies.
So, maybe the OPEC story will end not with U.S. shale bringing the cartel down, but with Saudi Arabia, one of the five original members, deciding to go it alone. Recent actions support the theory that they are willing to act as the lone decisionmaker when it comes to price and production.
Do it alone may be Saudi Arabia’s new oil mantra.
Carolyn Kissane is academic director and clinical professor of global affairs at the Center for Global Affairs at NYU School of Professional Studies. She is a non-resident fellow at the Payne Institute for Earth Resources.