The oil war risks becoming a three-way suicide pact
I have long been a devotee of the films of the great Sergio Leone, especially his Spaghetti Westerns. On a laughably threadbare budget, the great director made a virtue of his technical limitations, creating nothing less than a whole new look and feel in filmmaking.
The climaxes of Leone films are always a treat, perhaps nowhere more so than the hair-raising ending of The Good, the Bad and the Ugly, where—amidst the graves of a seemingly endless Union Cemetery, Clint Eastwood, Lee Van Cleef, and Eli Wallach engaged in a highly unpredictable and thrilling three-way shootout.
Read more: Oil’s rollercoaster ride continues
The film has kept popping into my mind as I survey the present energy war between the unhappy triumvirate of the United States, Russia, and Saudi Arabia. As in the Leone epic, a series of unforeseen consequences have led to this highly complicated and dangerous standoff. While there is still the potential for a happy ending, the present oil war could also turn a three-way shootout into little more than a suicide pact, with significant repercussions for a global economy already on its knees.
The energy war erupted on March 10, when the Russians surprised their Saudi allies-of-convenience by refusing to further ratify oil cuts that this OPEC-plus alliance had made in the energy markets over the past year.
During this time, while the Kremlin and the Saudis had cut oil production to stabilise energy’s shaky global price, the US shale revolution had taken advantage, carving out an ever-greater global market share at the expense of its two rivals.
Fed up with this state of affairs, the Kremlin—hoping to drive prices down to the point that shale production was no longer profitable—opened the spigots. This amounted to Russia trying to take advantage of the fact that with the price at around $42 a barrel drilling was still profitable for them, compared with $50 a barrel for the Americans, and more than $80 for the Saudis. Duly, Moscow declared that it was breaking with OPEC-plus and would pump an additional 300,000 barrels a day (bpd).
Then the Saudis threw a major spanner in the works. Blessed with the world’s greatest currency reserves, Riyadh dramatically changed course. Ramping up production to unheard-of levels, the Saudis (in the spirit of the first oil baron John D. Rockefeller) made it plain that they were prepared to lose money hand over fist in the short term, driving the price down to bankrupt its competitors, only then to pick up the pieces and regain its dominant market position.
Determined to at worst force the Russians back into the OPEC-plus alliance and at best regain market share, the Saudis, as of April 1, agreed to pump an unheard of 12.3 million bpd, up from 10 million. This wholly unexpected initiative sent wobbly oil prices tumbling. At the start of December 2019, the price of Brent crude was $66 a barrel. At the end of April 2020, it stood at just north of $20 a barrel, an unheard-of drop which gravely wounded all three.
All three great energy powers still have hopes they can best their two rivals, allowing each to continued the war. Of the three, the Saudis have the greatest currency reserves, and along with their OPEC-dominated allies, the greatest capacity to ramp up production.
The Russians have a far more diversified economy than Riyadh—as energy accounts for just 37% of its annual budget compared with 65% for the Saudis—and yet can tolerate marginally lower prices than the Americans.
The US shale forces, on the other hand, can in essence turn their pipelines on and off far more cheaply and easily than the big fixed-rigs which dominate Russians and Saudi production, thus proving to be more sensitive to price rises and falls, and far more flexible.
However, militating against a continuing oil war is the final thrill in this roller-coaster ride. Absolutely nobody in this shootout factored in the damage the coronavirus would do to global economic production. Just as prices were already swooning, global demand has fallen by as much as 30 million bpd, or a staggering 30%, due to the virus. This is where the shootout has the potential to become a suicide pact.
Goaded by an increasingly desperate President Trump, the Russians and the Saudis have agreed to stop the madness, cutting 10 million bpd from their outputs. But this is too little, too late to right the slump. The key question now is do these three ill-tempered energy gunslingers have the fortitude to make further cuts to save themselves, or will the final credits reveal three economically dead cowboys in the fatal bull ring.