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Simon Watkins

Simon Watkins

Simon Watkins is a former senior FX trader and salesman, financial journalist, and best-selling author. He was Head of Forex Institutional Sales and Trading for…

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The Inevitable Outcome Of The Oil Price War

One might reasonably posit that when Crown Prince Mohammed bin Salman (MbS) signalled that Saudi Arabia was once again going to produce oil to the maximum to crash oil prices in a full-scale oil price war, Russian President Vladimir Putin probably fell off the horse he was riding bare-chested somewhere in Siberia because he was laughing so much. There is a phrase in Russian intelligence circles for clueless people that are ruthlessly used without their knowledge in covert operations, which is ‘a useful idiot’, and it is hard to think of anyone more ‘useful’ in this context to the Russians than whoever came up with Saudi’s latest ‘plan’. Whichever way the oil price war pans out, Russia wins.

In purely basic oil economics terms, Russia has a budget breakeven price of US$40 per barrel of Brent this year: Saudi’s is US$84. Russia can produce over 11 million barrels per day (mbpd) of oil without figuratively breaking sweat; Saudi’s average from 1973 to right now is just over 8 mbpd. Russia’s major oil producer, Rosneft, has been begging President Putin to allow it to produce and sell more oil since the OPEC+ arrangement was first agreed in December 2016; Saudi’s major oil producer, Aramco, only suffers value-destruction in such a scenario. This includes for those people who were sufficiently trusting of MbS to buy shares in Aramco’s recent IPO. Russia can cope with oil prices as low as US$25 per barrel from a budget and foreign asset reserves perspective for up to 10 years; Saudi can manage 2 years at most.

A key reason why Russia can survive for so much longer than Saudis is actually thanks to MbS himself. Underlining this – and the fact that the Russians do have a very impish sense of humour, as they do – was that Russia’s Energy Minister, Alexander Novak, last week praised the co-operation of the OPEC+ grouping over the past three years, which, he added “had earned Russia 10 trillion rubles [US$140 billion].” Presumably just to highlight the irony of this further, Russia’s Finance Ministry then helpfully chipped in that the accumulated funds from the previous OPEC+ agreements will help Russia to support the ruble and will also help Russia to cope with oil prices as low as US$25 per barrel for up to 10 years. The metaphorical icing on the cake, though, was Novak adding that “we may reach new agreements [with OPEC] if needed”. In practical terms this means that if, in fact, it takes longer than originally thought by Russia for Saudi to go bankrupt and it starts to have any negative impact on Russia, then Moscow will just click its fingers together and Riyadh will come running to sign a new OPEC+ output cap deal. Related: Russia Sees Oil & Gas Income Fall By Almost $40 Billion

But surely, some may say, Saudi stands no chance of going bankrupt? In fact, as highlighted above, Saudi will absolutely go bankrupt if it continues this oil price war. As Saudi Arabia’s own deputy economic minister, Mohamed Al Tuwaijri, stated unequivocally in October 2016 last time that the Saudis tried this exact same ‘strategy’ from 2014 to 2016: “If we [Saudi Arabia] don’t take any reform measures, and if the global economy stays the same, then we’re doomed to bankruptcy in three to four years.” That is to say, that if Saudi kept overproducing to push oil prices down – just as it is doing right now, yet again - then it would be bankrupt within three to four years. The timeframe has halved for a variety of reasons outlined in my recent piece on this very subject here.

But what has Russia to gain from Saudi going bankrupt? Economically, it means that Saudi will default on sovereign and corporate debt, will not be able to service its key industries, and will be unable to meet the requirements for its major oil and gas contracts. Simply having less Saudi oil and gas competing in the same space as Russia and its allies – notably Iran and Iraq – would be benefit enough for Russia but there are even bigger added benefits too. One of these is the destruction of the already strained relationship between the U.S. and Saudi Arabia that has endured since 1945. At that time, as analysed in depth in my new book on the global oil markets, the deal that was struck between the then-U.S. President Franklin D. Roosevelt and the Saudi King at the time, Abdulaziz, onboard the U.S. Navy cruiser Quincy in the Great Bitter Lake segment of the Suez Canal was that the U.S. would receive all of the oil supplies it needed for as long as Saudi had oil in place, in return for which the U.S. would guarantee the security both of the country and of the ruling House of Saud.

Support in the U.S. for the continuation of this relationship has already diminished markedly in the past few years. This change in attitude began in earnest when it came to the U.S. public’s attention that 15 of the 19 hijackers who flew the aeroplanes involved in the ‘9/11’ terrorist atrocity on the U.S. were Saudi nationals. The extent of the Saudi government’s involvement in funding such terrorism appeared front and centre following the overriding on 28 September 2017 by the U.S Congress of former President Barack Obama’s veto of the Justice Against Sponsors of Terrorism Act. That made it possible for families of the victims of the ‘9/11’ terrorist attack to sue the government of Saudi Arabia for damages. Within a short space of time after this reversal, there were seven major lawsuits in federal courts alleging Saudi government support and funding for the ‘9/11’ attack, and more lawsuits are expected.

Subsequent events have not softened this negative view, with ongoing pressure from the U.S. Congress over the Saudi-led war in Yemen, the cosying up of Saudi to Russia in the OPEC+ grouping, and Lebanese President Michel Aoun’s allegation in 2017 that then-Prime Minister Saad al Hariri had been kidnapped by the Saudis and forced to resign. Matters grew worse with the murder of dissident Saudi journalist, Jamal Khashoggi, on 2 October 2018 at the Saudi consulate in Istanbul, Turkey, which even the CIA concluded was personally ordered by MbS. Such was the shift in sentiment away from Saudi over these years that the U.S. Presidential Administration has come under growing pressure to finally implement the  ‘No Oil Producing and Exporting Cartels Act’ (NOPEC). This bill – which can still be implemented, incidentally (apparently something else that MbS has not taken into consideration) - would make it illegal to artificially cap oil (and gas) production or to set prices, as OPEC and Saudi Arabia do. Related: Russia Needs Higher Oil Prices, But Won't Surrender

The bill would also immediately remove the sovereign immunity that presently exists in U.S. courts for OPEC as a group and for its individual member states. This would leave Saudi Arabia open to be sued under existing U.S. anti-trust legislation with its total liability being its estimated US$1 trillion of investments in the U.S. This, and all of the other aforementioned events, resulted in MbS being completely unable to find any international listing destination for the Aramco IPO. As highlighted ahead of the IPO in previous articles published in OilPrice.com, Aramco shares are now haemorrhaging value for precisely the key reason cited: that the company would be used as an instrument of government policy - however ill-considered - regardless of the considerations of shareholders.

Moreover, at the weekend, Aramco posted figures showing a 21 per cent fall in 2019 ‘due to a drop in oil prices’ – and this is before the new price-crashing strategy was put in place by MbS! After the ‘strategy’ announcement, the shares were trading at 15 per cent less than the offer price. In addition, again making a lie of its previous statements, it emerged at the end of last week that, despite its proven ridiculous claims by the Kingdom to boost supplies to levels never before even vaguely attained. Aramco rejected at least three Asian refiners’ (one Korean, one Taiwanese, and one Chinese) requests for additional crude for April, on top of their long-term supply deal.

So Russia, with Saudi Arabia either in the oil price war or better still bankrupt, benefits either way. The long-term goal of Russia is to control directly or indirectly all of the key players in the Shia crescent of power in the Middle East, including most immediately Lebanon, Syria, Iraq, Iran, and Yemen (via Iran). All of these countries have vast oil and gas reserves and/or useful coastlines for Russian military and commercial needs (Mediterranean access or access to the Arabian Sea). To do this, Russia’s core foreign policy strategy is to create chaos and then project Russian solutions and therefore power into that chaos. In this respect, again, MbS is being very ‘useful’ to the Russians.

By Simon Watkins for Oilprice.com

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  • Alex Alexander on March 19 2020 said:
    The only time period during which the oil price was above $80 is 2011-2014. Saudi Arabia would never be in business if its budget required $80 a barrel. Logic tells me that it is much cheaper to pump the oil in a desert close to the ocean into a giant tanker. It is much more expensive and difficult to pump the oil in the middle of Siberian tundra into a thousand kilometer pipe. What a joke.
  • Steven Conn on March 19 2020 said:
    Moscow has several things going for it:

    1. $123 billion rainy-day fund which is gathered in hard foreign currency. It is sold on the forex market to get rubles for funding the budget. This means that if the ruble weakens, the ruble amount in the fund grows. Selling the dollars/euros while buying rubles on the forex market also helps stabilize domestic currency. Its a sort of gyroscope.
    2. Flexible-floating exchange rate lowers break-even price for producing oil. As recently reported, Rosneft and GazpromNeft break-even price is $15-$18/barrel including lifting, transportation, and social taxes. Yes, the ruble has weakened significantly over the past month (by 25%, from $/64 to $/80), but this also lowered the break-even price for oil production.
    3. Russia has gathered $581 billion in foreign exchange reserves as of 3/1/3/2020.
    4. Besides oil and oil products, Russia exports gas, agricultural products ($25 billion), weapons ($15 bn), metals (including palladium, platinum, titanium, nickel, and gold), nuclear reactors and fuel, IT services, and rail-port transit services. It has a larger domestic market than the Saudis.

    In my opinion, what Moscow thinks is that rash Saudi move will hurt US shale much more, and that Washington will pressure Saudis to stop their price dumping. "Let Washington and the Saudis agree on the cuts while we wait". Moreover, by late summer, US shale and Canadian oil sands will have to curtail their production or go bankrupt further. Meanwhile Saudis are not doing to well in their Yemen quagmire, and drone/missile strikes on oil facilities are likely.
  • Jessie Phillips on March 19 2020 said:
    And yet gas prices are still at about $40 a barrel prices.......
  • Nessy Oil on March 20 2020 said:
    Essentially the money used to fund terrorist is gone now. The pain in the oil patch will pass. Bravo Putin and MBS. I now get why Trumps first meeting was with MBS. They planned this all along. Such great news. Trump really does care. Plus the US borders are closed today
  • Mamdouh Salameh on March 20 2020 said:
    By starting an oil price war with Russia, Saudi Crown Prince Mohammed bin Salman chose the wrong enemy. Aside from his country's ultimate loss of the price war and the eventual bankruptcy of its economy, he is dealing with the world’s most astute statesman and strategist, President Putin.

    With Prince Mohammed bin Salman facing Putin, the outcome is already decided. A short background about the rise of President Putin will tell the world why.

    With the dissolution of the USSR, Russia was on the verge of collapse. The antidote came from none other than Russia in the person of the “Siloviki.” The Siloviki are a group of highly skilled and patriotic leaders from the power structures of the former Soviet Union (the military services, the military-industrial complex). They began to play a role in 1999 with the appointment of Vladimir Putin as prime minister and then president of Russia. The aim of the Siloviki was to bring back to Russia the mineral resources that the Yeltsin government had given to foreigners. The Siloviki banded together in 1989 as a working group to evaluate the role and place of Russia in relation to the international situation as far as it could be foreseen for the next three decades. Based on their assessments, the Siloviki established a list of priorities for Russia’s survival.

    The first priority had to do with maintaining and improving the strategic nuclear arsenal as a deterrent against the United States. The second priority was to make good use of Russia’s network of gas pipelines. Any attempt to replace or compete with the pipeline that had supplied Europe in the Soviet era had to be blocked.

    The third priority was related to the second, and it required choosing a partner state, one that was highly developed in economic terms, in the immediate vicinity of Russia. The state that the Siloviki chose in 1989 was Germany, which became Russia’s partner. This partnership has allowed Russia to modernize its economy and its industry based on the German industrial model. In exchange, the Siloviki decided to support that country in becoming the locomotive of Europe, opening up to it Russia’s entire market. Germany was the only country brought in to invest in Russia’s gas transport and supply pipelines in Europe including the Nord Stream 2 gas pipeline. The Siloviki put pressure on Britain and France to get them to accept the reunification of the two Germanys, and the Siloviki offered the decisive role in this strategic game of wooing Germany to Lieutenant Colonel Vladimir Putin, former head of the KGB intelligence agency in East Germany. Germany became the drive belt to Putin’s Russia.

    Instead of imports, Russia preferred to encourage Russian companies to form “joint ventures” with Germany. Over 6,000 German companies are currently operating in Russia, providing at least 300,000 jobs to their subcontractors in Germany. Germany has been investing an average of € 20 billion per year in Russia since 1992.

    Putin was aware that the Americans’ technological advantage over the rest of the world had increased exponentially due to the dismembering of the USSR. At the same time, India and China were advancing, such that they were becoming a new centre of the world, threatening to supplant America.

    In 2006, Putin launched a common market for emerging countries called BRICS (Brazil, Russia, India, China, South Africa). BRICS is outside the US sphere of dominance and those who support it. This market comprises 50% of the world’s natural resources and population. BRICS has enabled Russia to withstand the economic sanctions imposed on it by the United States and the European Union.

    Rather than wage an unwinnable price war with Putin, Prince Mohammed bin Salman should endeavour to learn a lot from him and how he managed between 2014 and 2018 to extensively diversify the Russian economy enabling it to live with oil price of $25 a barrel, something neither Saudi Arabia nor the US shale oil industry can do.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London
  • Bob on March 20 2020 said:
    What part of Russia is the bulk of oil
    extracted.
    Is it heavy crude like the Alberta tar sands or lighter?
  • Jay L on March 20 2020 said:
    Sounds good... But, I wonder if you really have thought this out?
    I would ask, who puts them self into bankruptcy? and why?
    Trump has a larger stake in Russian oil, than the general public knows. Could the president be lining his own pockets. At the experience of the American people? Sounds like Trump all the way.....
    This is his MO! His aka! He is for self. His been lining his pockets and the pockets of friends and family fro the beginning. NO? Sure, just look at the facts. Trump has meet with suadis and Russians from the start. Was this the plan?
    Better look again, the elephant is stil in the room...
  • Stef G on March 20 2020 said:
    Given the oils production market is more of a three-way knife fight (OPEC, Russia, USA), what's the durability and longevity of US producers (and Canadian for that matter) in a protracted price war? Wouldn't be the first time Russian maskirovka would seem to be doing one thing (price war with the Saudis) while really trying to knock the North American production out of the game, leaving both Russia and the Saudis better off afterwards.
  • John Boyd on March 21 2020 said:
    I'm impressed with how Mr. Watkins has put together a coherent story around the oil price war involving the Saudis and Russia. What is even more impressive is that he has managed to do it without mentioning the elephant in the room which is the US attempts to block Russia from selling its energy products around the world. I guess if one doesn't notice that Russia started shielding it's economy from the US controlled financial system by:
    1. Turning every energy trade from a dollar trade into an energy for gold trade to build up gold reserves.
    2. By diversifying its means of supplying its energy products as well as its economy so that oil only represents 10% of Russia's economic output.
    3. Becoming self sufficient in many areas of its economy of which the most obvious area is in agricultural products.

    Then if you actually understand the way in which Russia functions, they always play the long game. As the US and EU launch petty attacks on Russia through sanctions and accusations of Russia meddling in elections, referendums, etc, Russia waited and waited until they could maximise the impact of a decision that they took would cause the most damage. AND NOW WE ARE HERE! Coronavirus, oil price war, financial collapse and existential crisis in the west!

    Simon, you're only half awake if you only notice half the strands!
  • Stephen Kennedy on March 21 2020 said:
    Why no mention of the total destruction of the shale industry in the US?
  • Stephen Kennedy on March 21 2020 said:
    Alex. SA's cost remain very low, but its budget (basically giving money to Saudis) and population have grown enormously. The budget shortfall based on oil price is a fact. Either the price/volume changes or the budget does, to avoid that. If they stop bribing the population there could be a revolution in SA against the royal family.
  • Stephen Kennedy on March 21 2020 said:
    Should really be a discussion of the likely destruction of the fracking industry in the US in this article.
  • Jason Walker on March 22 2020 said:
    About... half the stuff in this article simply is not true. For instance, the fact that the Aramco IPO failed on foreign exchanges had nothing to do with investors fearing US anti-trust legislation, or a price war with Russia (which no one, even Saudi, saw coming at the time). It had to do with the fact that the crown prince was insisting against all evidence to the contrary that Aramco was worth 2 trillion US dollars, when its actual, real world worth was more like 800 billion US dollars. He would not accept a dollar less than 2 trillion from foreign investors, and they would not pay him a dollar more than the 800 billion the company was worth at the time (it is worth considerably less now).

    The reason for this is basic stock market math: a company is either a growth stock or a cash cow. Aramco is not a growth stock, it will not have majority control sold to outside investors, and it is not going to do a share buyback. So the only thing that matters for its valuation is what the dividend return is going to be. This is especially true since it is an incredibly mature, conservative company, not a young up-and-at-em company looking to compete in new markets. This is a unique IPO in modern times.

    The crown prince first dictated how large (actually, small) the dividend would be, and then insisted that investors pay him a truly unreasonable amount of money for that tiny (percent-wise) dividend. The rate of return was not worth it, so investors said no.

    The fact that the author of this article - actually, the salesman trying to pawn off his terrible book - did not know even this basic fact about Aramco should tell you something about the veracity of the rest of his statements of, and I'm using this word in its lightest possible sense, "fact".
  • Mike M on March 28 2020 said:
    Russia can't cut production much without damaging their lifting and pipeline operations. COVID is here. They are screwed.

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