On 8 March’2020, Saudi Arabia, the world’s top producer of oil waged a price war against Russia which caused a 30% fall in oil prices. The largest single-day plunge since the 1991 Gulf War. In response, Asian stock markets closed significantly down with the carnage spreading over to the US, where the Dow slipped by 2,013 bps. It prompted the price of Brent crude, international oil marker, to fall as low as $31.02 per barrel. Saudi Arabia and Russia’s feud over oil is something on a global scale and cannot be ignored.
Saudi Arabia and Russia’s feud
The global oil demand had already fallen for the first time due to the outbreak of coronavirus. In response, Saudi Arabia wanted to reduce the supply of oil in world markets to which Russia did not agree. Russia wanted to assess the full impact of the coronavirus outbreak. It also wanted to test the US shale gas industry.
This made Saudi Arabia launch a price war as a lesson to Russia, which made oil prices sink a further 10%. Saudi Arabia started offering oil at unprecedented low prices to its purchasers announcing that it was cutting April’s selling price by $6, and planning to further increase the production.
What does it mean for the US shale gas market?
For the past three years, OPEC+, have cut supply to support prices, allowing US shale producers to capture market share.
The US is now the largest oil producer in the world, pumping out nearly 13 million barrels per day, but the companies are struggling to meet the expectations of the investors.
Shale companies need prices of at least $40 per barrel to cover its operating costs.
The US government recently forecasted domestic production would rise 1 million barrels per day (BPD) to more than 13 million BPD. But in light of reduced demand and OPEC’s higher output, oil production growth “will be roughly zero” compared with 2019, estimated Paul Mecray, managing director for Tower Bridge Advisors.
About Global demand:
Reduced global demand means the call on US shale will fall 2-3 million BPD, said Paul Sankey, a researcher at investment firm Mizuho Americas. That would imply an additional 20 percent reduction in oil companies’ spending this year, he wrote.
Can Saudi afford this price war?
Crude makes roughly 80% of Saudi Arabia’s revenues. As oil prices fall so do the country’s revenues. The future also seems to be moving against oil, with the Paris Climate Agreement spurring governments to reduce emissions and petroleum products.
The kingdom needs to diversify its economy at the earliest, which comes with a list of expenditures. Vision 2030 aims to free the kingdom from this trap by reinvesting fossil fuel wealth into sustainable industries of the future, shrinking the inflated state sector, and creating a diversified private sector to employ the kingdom’s young workforce.
This transformation also depends on convincing investors, both foreign and domestic, to buy invest in the vision. However, this price war has hammered the already lagging Vision 2030.
Can Russia afford this feud?
Under President Vladimir Putin, Russia has foreign exchange reserves of $570 billion allowing it to adjust adverse market conditions and devalue. The $570 billion reserves include the country’s National Wealth Fund, which stands at $150.1 billion or 9.2% of Russia’s GDP. The finance ministry said Reuters, the fund could be used to offset lower oil revenues if necessary. Can Saudi Arabia and Russia’s feud over oil afford this?
However, there are many problems. Russian President Putin needs to spend more. The oil boom of the early 2000s made Russia a strong economy—but now it’s harder. With economic growth at the focal point, demands increases in infrastructure investment and social spending.
Before oil prices collapsed, the government planned to tap the wealth fund to help drive a slew of projects central to its growth agenda. But a prolonged oil price war could force them to go back to scratch.
How did India benefit from the price wars?
Also, India imports more than 80% of its oil requirements, the price crash offers relief on the macroeconomic front. The collapse in oil prices will reduce the country’s import bill, and improve its current account deficit. According to findings, a one-dollar decrease in crude oil price reduces the bill by $1.6 billion annually. The fall in crude prices will also reduce inflationary and fiscal pressures. The growth slowdown in the last two years has resulted in a precarious fiscal situation because of tax revenue shortfalls. Saudi Arabia and Russia’s feud over oil has been beneficial for India.
Also, the revenue earned, can be used by the government to spend or meet its fiscal commitments in the form of budgetary transfers to states, payment of dues and compensation for revenue shortfalls to state governments under the goods and services tax (GST) framework.
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However, there could be a flip side for India too from the oil price slump.
Moreover, the value of Indian oil and gas companies will be impacted. Remittances from the Persian Gulf will reduce. Centre’s disinvestment program as the sale of Bharat Petroleum Corporation Limited (BPCL) could run into headwinds.