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.
Related: The Next Couple Of Months Are Crucial For U.S. Oil It 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.
Related: The Next Couple Of Months Are Crucial For U.S. Oil
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.
By Cyril Widdershoven for Oilprice.com
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Her first oil price war in the 1980s sent the oil price to $10 a barrel and cost it more than $50 bn in lost revenues. The second one in the aftermath of the 2014 oil price crash cost Saudi Arabia the loss of $118 bn in revenues and led it to sustain huge budget deficits of $140 bn in 2015 and $134 in 2016.
The third price war in March 2020 cost Saudi Arabia $12 bn in one month and exacerbated its budget deficit which will hit an estimated $116 bn before the end of the year. To this could be added another loss of $200 bn being a 10% devaluation of Saudi Aramco’s shares raising the total to $316 bn. Furthermore, Saudi Arabia has already been blamed by the Americans for inflicting huge damage on US shale oil industry.
A simple calculation will show that Saudi Arabia is bluffing when it threatens a fourth oil price war. Saudi Arabia currently exports on average 7 million barrels a day (mbd). At a price of $40, it will be earning an estimated $102 bn. It is fair to assume that starting another price war could lead to a collapse of the oil price to $30. To maintain its oil export revenue at $102 bn, it has to export 9.32 mbd. This entails a production of 13 mbd which it isn’t capable of. Saudi Arabia has never ever had a production capacity of 13 mbd. So raising its exports by 2.32 mbd could only come from oil storage. Saudi production peaked at 9.65 mbd in 2005 and has been in decline since. Saudi Arabia can at best produce some 8.0-9.0 mbd with another 700,000 b/d to 1.0 mbd coming from storage.
Saudi Arabia can dip into its stored oil. But in so doing, it will be depleting it fast thus reducing its ability to influence global oil prices or to benefit from a sudden rise in prices. Furthermore, this will expose its claims about having a spare production capacity to the world as a huge farce.
That is why Saudi Arabia will think twice or even three times before committing the folly of another oil price war.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London