On April 20, oil prices crashed to an unprecedented level, going into negative territory for the first time in US history. The initial collective international market reaction was a responsible and intelligent one. All members of OPEC+, with the exception of Russia, voted on March 6 in Vienna to cut oil output sharply in the face of the gathering threat to demand driven by the Covid-19 pandemic. However, this coordinated response was wrecked.
Full of hubris, Russia declared that it would not cooperate but would rather take full advantage of the crisis. Moscow refused to cut production, and even declared it would cancel cuts previously agreed to with OPEC+.
It made it clear that the aim was to hit US shale production sufficiently to force Washington to grant sanctions relief, especially those that had blocked construction of the Russian-German North Stream 2 pipeline.
This Russian declaration of a price war was a major and catastrophic miscalculation by President Vladimir Putin, who seriously underestimated the real severity of the pandemic and the depth of oil-demand destruction it would bring, overwhelming Russian oil production too.
As well, Saudi Arabia, undoubtedly with the full agreement of its Washington allies, had prodigious capacity to mount a counter-attack against this Moscow-declared price war in such a way as to undermine Russian oil sales dramatically in both its key Western European and East Asian markets.
The pandemic’s hit on economies worldwide has dramatically lowered oil demand to the likely tune of about 30 million barrels per day, roughly 30% of global pre-Covid production. Global storage is fast filling up. Perhaps two to three or four weeks remain for storage to be filled in this, then that, region of the globe.
At that point, whatever wells need to be shut down will surely be shut down.
However, the lack of a coordinated plan by OPEC+ and US producers, starting from March 6, to begin cutting production, plus the huge amounts of oil Saudi Arabia has since produced and marketed both to end the Russian price war and continue to savage Russian market share in retaliation, have meant that the collision of overproduction with underconsumption, of a big oversupply shock with a mammoth demand-loss shock, will be much more catastrophic and chaotic than it needed to have been.
Meanwhile in the US, President Donald Trump is dithering and purposefully avoiding taking any decisive action to begin shutting down wells in a coordinated and less-damaging manner for both the physical wells and the tens of thousands of workers and the companies involved.
He faces opposite demands for actions from, on the one hand, the very numerous smaller independent producers as opposed to the interests of the larger international oil companies.
Trump, together with OPEC+, with the Russians and Saudis, could have called for meetings of, for example, the International Energy Forum, which jointly represents producing and consuming states, to discuss orderly and coordinated cuts to mitigate as far as possible the sort of chaos and both resource and economic destruction we will see in the coming weeks and months.
This, or a similar gathering, could be accomplished at any time; but Trump, in particular, will dither, as with his public health response to the pandemic, and the crisis will only deepen.
It is no surprise the oil prices continued to drop even with the conclusion of the new OPEC+ agreement last week. What is noteworthy is that the WTI (West Texas Intermediate) benchmark for US crude oil has fallen much further and faster than the Brent crude benchmark.
Even though its significance is high but not as high as we could imagine, this latest event could have major impacts on geopolitics. The US Congress is likely going to try to find a scapegoat for all these issues. In this case, the scapegoat will be easily found; it will be Saudi Arabia.
The reason the Saudis are likely going to be the scapegoat is that they massively boosted exports as a result of OPEC+ talks with Russia failing in early March. In addition to this, the technicalities of the oil market are such that Saudi oil exports to the US are reaching a one-and-a-half-year high.
For Russia, lower oil prices will be hurtful if they stay that low for the medium term, but the Kremlin is greatly appreciating the fact that the US is going to take a much bigger hit. In the short term, the situation will be catastrophic for producers in the Organization of the Petroleum Exporting Countries that have a high dependency on oil in their export basket: the likes of Iraq, Algeria, Angola, Nigeria, Gabon and the Congo Republic.
For Gulf Cooperation Council producers (other than Saudi Arabia), the pain will be there, but it will bearable thanks to the comfortable financial cushion they enjoy through their sovereign wealth funds’ investments and foreign reserves. But geopolitically, this crisis could mark the beginning of a shift for these countries.
Given the grim outlook for oil in the long term, they may not ever recover their past riches. Their suffering could come very quickly: In the 2014-2018 period, net financial assets held by the six Gulf monarchies fell by around half a trillion dollars, to around $2 trillion. The lack of diversification of their economies makes them vulnerable in the longer term.
Budget cuts will also have geopolitical implications as their defense budgets could be among of the first to see cuts. This, in turn, could impact their strong relationships with the US and Western Europe, which are major suppliers of weapons and artillery.