By Keith Reid
Roughly one month ago I wrote a synopsis of the oil war that was shaping up between Russia, Saudi Arabia and the United States. You can find it HERE with the details, but in general Russia was taking advantage of the demand destruction caused by the COVID-19 pandemic to pressure Saudi Arabia into maintaining higher production to further depress oil prices.
On the surface this would seem counter intuitive, since both Russia and Saudi Arabia depend so heavily on oil revenue to keep their countries running. However, Russia’s goal was to seriously damage U.S. fracking production, which is notably more sensitive to lower oil prices than conventional crude. Russia also expected to challenge Saudi leadership of the 20-nation OPEC+, which had been working to keep global oil prices more moderate.
The strategy had a precedence. The Saudi’s had tried to tank oil prices and cripple the U.S. fracking industry in 2014-2015, and as I noted in the previous article this ultimately fizzled out. Saudi Arabia simply couldn’t withstand the economic pressure.
Apparently that lesson has been relearned. As Bloomberg covered on April 12, after briefly (and massively) ramping production to counter Russia decision not to cut production the Saudi’s folded and the Russians backed off. There is now a solid buy in to cutting production throughout OPEC+. Currently on the table is a cut in production of 9.7 million barrels a day.
This is seen by the punditry as being a bit inadequate, but a step in the right direction. It has had mixed results on the markets with the economic downturn from COVID-19 still raising serious demand concerns.
President Trump tweeted his support for the developments. “The big Oil Deal with OPEC Plus is done. This will save hundreds of thousands of energy jobs in the United States. I would like to thank and congratulate President Putin of Russia and King Salman of Saudi Arabia. I just spoke to them from the Oval Office. Great deal for all!”
Trump is cited as helping walk through the deal, and apparently made significant efforts along those lines. Perhaps his most effective efforts didn’t involve such direct negotiations, but his stated willingness to support the U.S. fracking industry through the downturn. There is also the reality that the current and foreseen demand destruction will likely continue to have a massive impact on their own.
Ultimately, Russia and Saudi Arabia had to cool their tempers and egos and take a long, hard look at the economic abyss staring them in the face. As I noted in the previous article Argus Global Markets estimates that 65% Saudi Arabia’s economy is dependent on oil and for Russia that dependence is 37% and this is in the face of a brad economic disruption beyond the oil markets.
Considering such a dangerous economic war reminds me of the nuclear war concept of “mutually assured destruction” (MAD), as illustrated in the 1983 cold war thriller War Games. With MAD, nuclear war was considered too terrible to ever be intentionally used as an acceptable strategy. The Saudi strategy to force the issue might have paid off, but what if Russia and not folded? For oil, under normal circumstances Russia or the Saudi’s waging an aggressive oil war is a very dangerous option. Under the current environment it is practically suicidal.
In War Games, high school hacker Matthew Broderick hacks into an Air Force strategic nuclear command AI program and accidentally initiates a potential nuclear first strike against the Soviet Union. Spoiler alert—the AI eventually runs through all the possible victory scenarios and determines “the only winning move is not to play.”