Why did Saudi Arabia start an oil price war?

Global benchmark oil prices took their biggest single day plunge in 30 years on Monday after Saudi Arabia said it would increase oil production even as global demand has slumped in the wake of the coronavirus outbreak.

In response, Asian stock markets closed significantly down on Monday with the carnage spreading to the US, where the Dow Jones Industrial Average closed down 2,013 points, or 7.8 per cent, in its single-day biggest point drop ever. The situation stabilised somewhat on Tuesday in Asia with benchmark indexes in Sydney, Hong Kong and Shanghai rising.

The outbreak had already hit oil prices as the circulation of people and goods around the world has slowed dramatically amid curbs imposed in an effort to slow the spread of the virus.

“With demand already falling like crazy, the timing of this is horrible,” said Jim Krane, fellow at Rice University’s Baker Institute of Public Policy in Houston. “It’s a lot of oil with no place to go.”

What happened?

Saudi Arabia, the world’s second largest oil producer, started a price war over the weekend when it slashed crude prices by the largest margin in two decades and said it would ramp up production.

The price cuts come as an alliance between Saudi-led oil cartel the Organisation of the Petroleum Exporting Countries (Opec) and Russia, which had been supporting oil prices, collapsed on Friday with Russia refusing to curb its own production in response to plunging global demand.

Analysts say Riyadh’s moves, which on Monday caused international benchmark Brent crude prices to crash to US$33(RM97) a barrel from nearly US$69(RM291) at the beginning of the year, are an attempt to demonstrate Saudi Arabia’s dominance of global oil markets. The US benchmark West Texas Intermediate on Monday also sank to US$27.71(RM117) a barrel.

“A price war is a blunt instrument,” said Krane. “It hurts everyone who produces oil. It’s like a bunch of friends holding their breath to see who can hold it the longest.”

While Saudi Arabia has the wealth and oil resources to outlast many other countries, experts say these moves will not come without a cost for Riyadh, as its economy is dependent on oil money.

What made Saudi Arabia cut oil prices?

Global demand for oil had already fell for the first time in a decade because of the outbreak of coronavirus, which causes a pneumonia-like illness known as Covid-19 that has killed almost 4,000 of the more than 110,000 people it has infected worldwide so far.

Friday’s talks between Opec and Russia, which have jointly supported oil prices since 2017, were initially intended to figure out a way to bail out the global oil market.

But after Russia’s refusal to cut production and the subsequent collapse of negotiations, crude oil prices sank a further 10 per cent.

In what analysts say is an attempt to pressure Russia to reconsider, Saudi Arabia began offering unprecedented low prices to foreign purchasers, including in the US, Asia and Europe – announcing that it was cutting April’s selling price from US$14(RM59) to US$8(RM34), and laying out plans to further ramp up production.

Russia claims it refused to cut supply because it is waiting to see what the full impact of the outbreak will be on oil demand, but experts say Moscow may also be hoping to cut the knees out from under US domestic shale oil production after Washington sanctioned Russian energy companies.

Amy Myers Jaffe, an oil and Middle East expert at American think tank the Council on Foreign Relations, told The New York Times, “If you’re Russia, it’s worth it for you to take a three month price hit to see if you can knock out US oil exports.”
Jaffe said that the divergence in Saudi and Russian strategies “signals that the relationship between Saudi Arabia and Russia is on the skids”.

The US produced 18 per cent of the world’s oil supply in 2018, compared with Russia’s 12 per cent, according to the US Energy Information Administration – and has attracted customers who could have otherwise bought from Russia.

In an email over the weekend, political risk consultancy Eurasia Group described Russia’s President Vladimir Putin and Saudi Arabia’s de facto leader Crown Prince Mohammed bin Salman as “inflexible at times” and predicted that a deteriorating relationship between the two could contribute to an open price war between their respective nations.

However, the group’s analysts said they “do not see this as a strategic break between Russia and Saudi Arabia, nor do we draw any direct connection between the Opec events and the arrests of Saudi royals last week.”

How could this affect other countries?

While analysts say Saudi Arabia’s actions are aimed at punishing Russia, they could also have repercussions for oil dependent nations such as Venezuela and Iran, who are already under pressure from US sanctions and American competitors.
US shale and Canadian oil sands producers are likely to feel the squeeze, as are emerging economies that depend on oil such as Brazil, Angola and Nigeria.

If the low prices continue, other oil producers may have no choice but to scale back production.

Experts say Saudi Arabia has the capacity to boost production faster than Russia can, and could even pull some supplies from storage to increase exports quickly.

If the global economic damage resulting from the coronavirus outbreak is long lasting, Riyadh may recalibrate its position, according to the Eurasia Group, but a major incentive for Saudi Arabia to keep prices low is China.

China has historically stockpiled oil during times of low prices to avoid having to purchase when prices are high, and could be a primary buyer of the Saudi’s discounted oil. China consumed nearly 14 million barrels a day in 2018, second only to the US, which consumed nearly 20 million.

“If China has room in its strategic storage, this would be a great time to top it up,” said Krane of Rice University.
Indian oil refiners are also looking for good deals, after they recently snapped up unwanted barrels of crude oil originally destined for China amid the virus-led demand slump, Bloomberg reported, quoting R. Ramachandran, the refineries director of India’s Bharat Petroleum Corporation who said oil buyers would be “spoiled for choice”.

Aren’t low oil prices a good thing for consumers?

Many people around the world are foregoing travel and staying home to combat the spread of Covid-19 despite low fuel prices. Airlines have slashed routes and the hospitality industry has axed jobs in hotels and restaurants while people stay home, meaning cheaper prices will not necessarily lead to more demand for fuel until the outbreak is contained.

Major UK oil companies BP and Royal Dutch Shell lost nearly US$42billion (RM177billion) in combined market value on Monday amid the price shocks. According to equity research firm Redburn, Shell requires oil prices of US$65(RM275) a barrel to break even, and BP US$53(RM224) – last year’s average Brent price was US$64(RM270).

The International Energy Agency said on Monday that global oil demand could decline by as much as 90,000 barrels a day this year.

What else is going on in Saudi Arabia?

Power in Saudi Arabia is wielded by 34-year-old Crown Prince Mohammed bin Salman, who has consolidated leadership on behalf of his father, King Salman, 84.

The crown prince has cultivated a reputation for being unpredictable, ruthless and ambitious, and now controls the kingdom’s military, internal security forces and national guard.

His leadership has been marked by international condemnation over the 2018 killing of Washington Post columnist Jamal Khashoggi at the Saudi Consulate in Istanbul and a five-year military intervention in Yemen that has caused one of the world’s most severe humanitarian crises.

Cranking up oil production right now during the virus outbreak is a pretty risky move, but Saudi Arabia is a country that can withstand low prices. MBS has certainly shown himself to be a risk-taker, and this does fit with his profile,” said Krane of Rice University, referring to the crown prince by his initials.

Saudi Arabia is currently producing about 9.7 million barrels of oil a day, far from its estimated capacity of 12 million barrels.

Shares of Saudi Aramco, the Saudi national oil company, plummeted by more than 9 per cent on Sunday. Bin Salman led the charge to take Aramco public in December of last year, and analysts say weaker share prices could cause the crown prince’s reputation to take a hit – and possibly even jeopardise his ambitious economic development programme, Vision 2030.

Since assuming power, Bin Salman has cracked down on dissent and over the weekend a fourth senior prince was reportedly detained at his behest. Those detained include a former head of army intelligence, Prince Nayef bin Ahmed, and his father Prince Ahmed bin Abdulaziz – the last living full brother of King Salman, who analysts had earlier thought would be insulated from the crackdown.

The Saudi royal court has accused the two men of “plotting a coup to unseat the king and crown prince” and they could face lifetime imprisonment or execution, according to The Wall Street Journal.


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