The feeble surge in oil prices on April 3 reflected the markets’ optimism that a truce in the Saudi-Russian oil war may be at hand. As the OPEC+ producers prepare to meet on April 6, it is worth trying to assess the motivations behind Saudi Arabia’s decision to launch such a war, as well as its implications for the Kingdom itself.
First of all, Saudi Arabia’s recent weaponization of oil can be seen as a side effect of the ongoing personalization of the kingdom’s oil policy. Over the last few years, across a wide variety of sectors there has been a growing centralization of policymaking, which has gone hand in hand with the consolidation of power in the hands of Crown Prince Mohammad bin Salman (MBS). In today’s Saudi Arabia, decisions are personal, and this person is MBS. The centralization of oil policy has been in sight since September 2019, when veteran Saudi Energy Minister Khalid al-Falih was replaced by Prince Abdulaziz bin Salman, MBS’ half-brother and the first member of the royal family to hold the post. The centralization of energy policy is key to making it instrumental to the realization of the Vision 2030 reform agenda, the crown prince’s flagship initiative. Another evidence in this sense is the handing over of the chairmanship of Saudi Aramco to Yasir al-Rumayyan, a member of MBS’ inner circle and the head of the Saudi Public Investment Fund (PIF), the sovereign wealth fund which has been leading the diversification effort through investments both abroad and at home. In order to finance its investments, the fund needs high oil prices. The coordination with Russia in the framework of OPEC+ since 2016 has been serving exactly this purpose, keeping the prices elevated at around $50-60 per barrel, at least until the latest OPEC+ summit, on March 6.
Russia’s refusal to agree to production cuts at a time of weakening global demand due to the coronavirus outbreak (allegedly because of Moscow’s desire to push US producers out of the market), prompted Saudi Arabia to change its strategy. Unable to pursue the initial objective of shoring up oil prices, Riyadh opted for flooding the market with its oil (planning a 2.5 million-barrel per day increase from April), thus launching a war for market share. The KSA seems to be betting on being able to outlast the US, Canadian, and Russian competition. Saudi oil is indeed cheaper to extract and transport than many other producers’, and Saudi Aramco is one of the most competent and technologically advanced oil companies.
This is, however, a bold move, which seems to be driven also by the need to extract maximum value from its oil reserves before the global clean energy transition takes full steam. No more prudent management for future generations, rather the need to maximise revenues while it can (the estimated time horizon before clean energy overtakes fossil fuels is 20 years). Indeed, the choice to maximize oil production is reflected in another recent event, the settlement in December 2019 of the long-time dispute with Kuwait for exploitation rights in the Neutral Zone, which will increase Saudi production by up to 500,000 barrels per day.
Nevertheless, this low-prices strategy will bear high costs for the Saudi coffers. According to some estimates, the kingdom has a two-year buffer. Indeed, these are already hard times for the Saudi budget, which is under the double strain of the coronavirus crisis and the low oil prices. With its net financial assets already fallen from 50% of GDP to 0.1% in the period 2014-2018, the kingdom is likely to soon become a net debtor.
But this strategy also risks bearing political costs. According to some reports, the Saudi decision to raise production was “unnerving for its partners, who felt compelled to fall into line”. For the moment, Gulf producers are closing ranks with Saudi Arabia, following Riyadh in planning an increase in oil production. This seems to be the only choice if they want to maintain current revenues in the face of falling prices. However, as regional economies have yet to fully recover from the 2014 low prices, and now have to fend off the economic impact of the coronavirus, it is reasonable to expect growing discontent with this “Saudi-first” strategy. The UAE, for which the break-even price is $70, and which is now experiencing the pain of being a global trade and travel hub at a time of trade and travel disruptions, has been not surprisingly pushing for a new Saudi-Russian agreement.
The US Secretary of State, Mike Pompeo, also expressed his concern and urged Mohammed bin Salman to “rise to the occasion” and reassure energy markets. While President Donald Trump had initially praised the Saudi move as positive for the American economy, the perspective of shale producers going bankrupt and the threat to US energy independence – especially in an electoral year – made him change his mind. Indeed, it was allegedly the US pressure on MBS himself to cause the Kingdom to “call for an urgent meeting of OPEC+ and a group of other countries, with the aim of seeking a fair agreement”. While formally the Trump administration cannot impose cuts on US private producers, the US president can of course facilitate them.
Should the US producers agree to cut their production, and should Russia be satisfied and agree to cut its own too, the Saudi gamble would be paying off. Yet, a lot of questions remain as how long a new agreement would last, and, even more importantly, how much each country is willing to cut in light of the huge demand decline.
As Saudi Arabia embarks on an all-out war driven by the crown prince’s bold bet, the actual question one should probably ask is not (only) whether Saudi Arabia can win over Russia, rather: can it make it without allies?