It cost the global energy market almost two months of spectacularly low oil prices but, with the largest deal to cut production in history, Saudi Arabia has won the oil price war. Riyadh coordinated an agreement between OPEC+ – the Organisation of the Petroleum Exporting Countries, along with non-members such as Russia, Norway, Mexico, Argentina, Colombia, Ecuador, Egypt, Indonesia, Norway, Trinidad and Tobago – and the G20 to achieve two key Saudi objectives. The first was to persuade other producers that they must shoulder some of the burden of cutting production to stabilise the oil market; the second was to reaffirm Riyadh’s leadership of energy geopolitics, a prized asset that lends it significant influence. This was, however, a long and costly journey, beginning in February with the coronavirus-induced fall in Chinese energy demand. And there is a high risk that the deal is too little, too late: with no sign that oil prices will rise sustainably, Riyadh may have unleashed something it is unable to control.
The energy market has been grasping with decreasing global demand for a long time. Yet the lockdown many nations have implemented to contain the spread of covid-19 was a coup de grâce. It reduced demand for oil in the largest global consumers in Asia, especially China, and in the most fuel-hungry industry, aviation. Saudi Arabia, whose top export destination is China, was the first to notice these trends and to argue for production cuts to prevent a free-fall in prices. Other top oil producers, especially Russia, which was less affected in February, refused to go along – out of fear that, in the long run, it would lose market share. Saudi Arabia reacted by raising oil output to record levels in March and April while offering substantial discounts on its crude, especially to Russia’s customers in Europe. The strategy, which caused oil prices to plunge to their lowest levels in 18 years, was to strong-arm other producers into negotiating according to Saudi conditions. Two months later, it worked.
Last weekend, Riyadh hosted two crucial meetings. One, the most important, involved OPEC+; the other involved the G20, of which Saudi Arabia holds the presidency this year. After many days (and late nights) of talks, the OPEC+ meeting produced a historic deal to cut production by 9.7 million barrels a day in May and June, an arrangement endorsed by the G20.
However, Riyadh truly reached the agreement in preliminary bilateral talks with Moscow, its most important competitor and the main target of the Saudi strategy. This discussion seems to have been partly mediated by US President Donald Trump, who had become increasingly concerned about the impact of low oil prices on his country’s energy industry. (Indeed, Trump unofficially agreed to pick up some of the oil production cuts demanded of Mexico – whose staunch refusal to adopt its suggested quota kept other states on edge for three days – to get the final deal across the line.) Both Russia and Saudi Arabia agreed to lower their output to 8.5 million barrels a day – a quota that, given February’s baseline, would mean larger cuts by the former. Riyadh was so confident the deal would hold that, before the OPEC+ meeting, it directed its sovereign wealth fund, the Public Investment Fund (PIF), to buy stakes worth $1 billion in four major European oil companies: Italy’s Eni, Royal Dutch Shell, Norway’s Equinor, and France’s Total. The rationale was that, much like oil, these companies’ shares would rise in value once the deal was formalised.
Yet the market has not reacted as enthusiastically as expected, with Brent Crude still struggling to lift off $30 barrels per week. There are several reasons for this, two of them critical. Amid a full-fledged economic recession, oil analysts view the agreed cuts as being inadequate relative to the fall in demand, with JBC Energy calling the OPEC+ deal “just a plaster on an open wound”. Globally, oil supply is likely to continue to exceed oil demand. In addition, compliance with such deals is always problematic, and countries are likely to cheat – particularly in this case, given that some producers may have agreed to more than they can deliver. For instance, Trump may have said that the US will cut production by 300,000 barrels a day to cover for Mexico, but it is unclear whether he can achieve this given that, within the US economic model, firms have traditionally resisted any government interference.
The market has not reacted as enthusiastically as expected, with Brent Crude still struggling to lift off $30 barrels per week
Riyadh may now feel satisfied, having asserted its will and consolidated its leadership of the global oil market. Riyadh will not be unhappy to have seen some its competitors struggle, including shale gas producers in the US, and to have made the point to Moscow that, in future, Russian policy should fall in line with the Saudi oil strategy.
But the episode is not over, and the risks remain high for Saudi Arabia. There may be a political price to pay. For example, the collapse of the American energy sector is beginning to affect US-Saudi relations. Members of Congress intensely lobbied the Trump administration, and wrote several open letters to urge Crown Prince Mohammad bin Salman, to end the oil price war (even if this involved unilateral action), arguing that US-Saudi relations were at stake. Senators from the Republican Party even introduced two consecutive bills calling for the removal of US troops from Saudi territory, aiming to place Riyadh under pressure in the negotiations.
Both Trump and Secretary of State Mike Pompeo were in constant communication with the Saudis and even appointed a special energy envoy to liaise with Riyadh. Saudi Arabia may have persevered to the point that the US joined a coordinated production cut, but this episode adds to a list of caustic controversies in US-Saudi relations. Indeed, the US is likely to move away from Saudi Arabia on a series of issues, especially if oil prices remain low.
The oil price war has also had an impact on Saudi Arabia’s relations with Russia. It ended almost three years of Saudi-Russian cooperation in energy geopolitics, which underpinned broader bilateral dialogue on political and economic issues. Discussions between Investment Minister Khalid al-Falih – Saudi Arabia’s preferred go-between with Moscow, an OPEC veteran, and a former energy minister and Aramco chairman – and Russian Energy Minister Alexander Novak reportedly became very tense, even straining relations between higher-ranking leaders.
More immediately, and perhaps of greater significance, is the oil price war’s impact on all producers whose budgets depend on energy revenues – especially as they face rising expenses for healthcare and economic relief packages due to covid-19. Saudi Arabia itself is on alert, planning for massive loans and the privatisation of state assets. While the PIF is on a low-cost, high-profile shopping spree, snapping up undervalued assets at bargain prices, Riyadh announced in March that it would reduce government expenditure by $13.2 billion, or nearly 5 percent of its budget for 2020. And it has prepared emergency plans to scale back expenditure by an additional 20 percent. Hence, if this economic recession is anywhere near as bad as it looks, there will be more late-night OPEC meetings in a few months’ time. Yet it is unclear whether Saudi Arabia will retain its coercive capabilities and leadership capacity in the next set of negotiations.
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