Russia, Saudi Arabia play 'who-blinks-first' over crude price; scramble over market share gives Indian oil firms 'additional bargaining power'

Oil experts are left scratching their head in the aftermath of the OPEC+ meeting in Vienna held on March 5 and 6 as most variables of the oil market are left in flux. In a move that has shaken the crude landscape, Saudi Arabia has launched an oil war against Russia by announcing that it will hike oil production 12.3 million barrels per day (mb/d) from April, and has also offered deep discounts to its buyers, potentially swamping an already oversupplied oil market.

The story so far

The exacting decision by Riyadh to spike production was triggered by the failure on Friday to strike a deal with Russia on a new round of OPEC+ production cuts to arrest swooning oil prices owing to the novel coronavirus.

A surge of shale oil from American production sites — today, the US is the world’s largest oil producer — has kept the pipelines brimming over. In an attempt to rebalance the markets, OPEC led by Saudi Arabia plus non-OPEC producers, like Russia—forming an unwieldy alliance called the OPEC+ group–have been making quota-based group cuts to production. Under the existing pact, which kicked in last December and ends this month, a total of 2.7mb/d oil was taken off the market.

However, since January, the novel coronavirus outbreak has eaten into Chinese growth and supply chains slamming global oil demand—petroleum prices have already fallen by 30 percent this year. A recommending body of the OPEC+ cartel, comprising representatives of producing countries, called the joint technical committee asked for a 600,000 b/d reduction in production to bring relief to the oil market. However, Riyadh wanted to cut production by 1.5 mb/d after March—a proposal that was unpalatable to Kremlin resulting in collapsed talks.

Since the kingdom’s retaliatory decision, the market response has been violent with Brent crude futures plunging Sunday night by the most since the Gulf War began in 1991 and oil prices diving by 20 percent.

Divergent interests

The complicacy in stitching together this fractious, large group of elite oil producers are located in divergent political and economic interests. The Kremlin’s budget easily accommodates a $40 a barrel oil whereas Riyadh is under pressure to keep prices over $60 to support Saudi Aramco’s share price and also to realize their ambitious Vision 2030 reforms that include weaning the economy off oil.

Additionally, Moscow has become wary of yielding market share to US shale and new producers, like Canada and Norway. The endless clamping down on production was hurting Russia—which was reflected in its weak compliance to the OPEC+ pact. Additionally, Russian intent for not agreeing to deepened cuts in the second quarter is directed at breaking the back of the shale industry by ensuring oversupply heavily compresses crude price, in turn, weeding out operators that are working on breakeven prices.

This about-turn by Moscow also comes in the heels of the wound inflicted by the Trump administration in the form of sanctions imposed on Rosneft Trading and its consequent deleterious impact on the Nord Stream 2 project–a new export gas pipeline running from Russia to Europe across the Baltic Sea. The US energy secretary Dan Brouillette recently said at the Munich security conference that this means the project will face “a very long delay because Russia doesn’t have the technology”. Russia, reportedly, has now turned to Kiev to deliver this gas. Nord Stream 2, which would have pumped as much as 55 billion cubic meters of gas annually from producing fields in Siberia to Germany has become a new source of tension as the Trump administration is aggressively seeking energy markets in Europe and Asia. The decision to walk away from extending or deepening the existing pact is Moscow’s retort to foil the U.S. oil strategy.

Possible scenarios

The oil market is treading uncharted territory as both global demand and supply are beyond the grip of reasonable predictability.

“With a combination of a massive supply overhang and a significant demand shock at the same time, the situation we are witnessing today seems to have no equal in oil market history,” said Fatih Birol, executive director of the International Energy Agency (IEA)—a Paris-based agency that monitors energy markets for developed nations. World oil demand is set to fall for the first time since 2009 with IEA downwardly revising its demand estimates by one mb/d.

Russia and Saudi Arabia — two of the world’s biggest oil producers — are now entangled in a who-blinks-first game in a race to grab market share. Saudi Aramco is offering deep discounts to its customers for April. It would slash next month’s official selling prices (OSP) by $4­-$6 to the Far East, $7 on all American grades and $7­-$8 to northwest Europe.

The Russian energy minister Alexander Novak when leaving the Vienna meeting last week said that “from 1 April, we are starting to work without minding the quotas or reductions which were in place earlier” while Saudi Aramco has declared that it will swamp the markets by producing at 12.3 mb/d from next month. Riyadh’s strategy aims to drag Moscow back to the negotiating table.

Though a meeting between the warring parties to seam a pact before the end of the month is not ruled out, smaller producer countries and entities are caught in this massive ego battle. If this endurance test goes unchecked, it will be a race to the bottom for producer countries.

“$20 oil in 2020 is coming,” Ali Khedery, formerly Exxon’s senior Middle East advisor, wrote Sunday on Twitter.

$20 oil in 2020 is coming. Huge geopolitical implications. Timely stimulus for net consumers. Catastrophic for failed/failing petro-kleptocracies Iraq, Iran, etc - may prove existential 1-2 punch when paired with COVID19. https://t.co/cw5uzDz8Yx

— Ali Khedery (@alikhedery) March 7, 2020

A scramble for market share among the three largest oil producers—the US, Russia and Saudi Arabia—is reminiscent of a 2014 scenario.

Another scenario is a conspiracy theory among a small group of experts — usually associated with such events of global significance — also believes this could be an attempt by Russia and Saudi Arabia to lame the shale industry. Potentially, this line of argument may not be an altogether fictional narrative.

“The trend that Saudi Arabia sets will make other Middle East oil producers follow suit. It is a mature market,” said MK Surana, CMD, Hindustan Petroleum Corporation Limited.

It is still early days to predict the impact of this spiralling oil war on the American shale industry. Though shale arithmetic is based on high crude prices to rake in profits, the industry is not a homogenous category of oil producers—the big players have balance sheets capable of withstanding even $25-$30 crude prices, Surana said.

The thriving American oil industry mostly consists of independent producers, unlike the case for the Middle East region or Russia where they are government-controlled. Though the smaller drillers, in the short run, maybe shoved out of business over a medium-term fresh capital into the sector will dry up affecting the sturdier entities as well if testingly low crude prices continue.

While millions of barrels of oil are set to flow in next month, the commensurate demand to absorb this quantity does not exist. Experts are still grappling to peg the total impact of the novel coronavirus on the economy with Chinese demand and supply chains in disarray. The oil market could end up with a 700,000 b/d surplus for 2020 unless OPEC+ shuts the oil spigots, Energy Intelligence’s balances show.

The low crude prices have a salubrious effect on the exchequer of buyers, like India. Also, the slashing of OSP by Riyadh is of bigger relevance than increasing supplies, argued Sanjiv Singh, CMD, Indian Oil Corporation Limited. “Lower OSP would help in improving gross refining margin, which otherwise was abnormally due to poor cracks,” the Indian Oil Corporation CMD said.

On the flip side, in a long-term, lower price destroy supplies crippling investment in the upstream sector. Sudden shocks also create inventory losses, which become a concern for oil marketing companies given the buying price was $65 for the current stock.

“For the short-term, the prices are going to be low. This [a race for lower crude prices among producers> also means additional bargaining power for countries, like India,” Singh said.

The decision not to participate in production cuts is a well-calibrated move by Russia and not a whimsical volte-face as it may appear to be. Riyadh will not be able to sustain the burden of production cuts without the nod of its one-time ally — Russia — given the current state of many of its members, including a sanctioned Iran, a torn Venezuela, Libya and Nigeria, which contribute little to the global oil market.

The erstwhile all-powerful OPEC group may have reached the limits of its influence as it negotiates new oil realities.