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Oil Glut

Posted on 13-Mar-2020 Comments  0

Oil Glut

Saudi Arabia has triggered an oil war; but where will it end?

The Vienna meeting between the OPEC and Russia failed to reach a consensus leading to Saudi Arabia adopting an Oil Flooding policy. What triggered this oil war and what could be the eventual outcome of this oil price war?

Why the Vienna talks failed

In many ways, the Vienna talks were a non-starter. The OPEC and Russia were already cutting oil supply by 2.1 million bpd. Now OPEC was demanding an additional cut of 1.5 million bpd taking the total cut to 3.6 million bpd. That was something Russia was not willing to commit itself. Russia knew well that any price rise at this point would benefit the US and give its shale companies a life line for the future. That is what forced Russia to stay away as past experience was that only the US had benefited. Putin wanted to avoid a lifeline to shale.

For Saudi it was all or none

Prince Salman was quite clear in the beginning that 2.1 million bpd was just not sufficient considering the 20% fall in demand from China post Coronavirus shutdowns. The preferred option was to make a big cut in supply so as to benefit when Chinese demand picked up. If that did not work out, Saudi Arabia’s Plan-B was to flood the world markets with oil so as to push Russian and American oil companies to a corner. After all, the break-even for the US and Russian drillers is substantially higher than KSA.

Triggering the price crash

The day after KSA announced its plan to raise oil production to around 12 million bpd, the price of oil crashed by nearly 30% in a single day. That was hardly surprising because KSA was adopting a policy of supply glut with price cuts. For example, Saudi Arabia had cut oil prices to as low as $30/bbl for some of its clients and had promised much lower rates across Asia and Europe. While the break-even for Saudi Arabia is lower than the US and Russia, it would still incur losses at current prices. But with a forex chest of nearly $650 billion, Saudi Arabia has the luxury of pursuing this price war for at least the next 2 years. The hope would be that by then the oil demand from China will pick up.

Becoming swing producer

The larger agenda for KSA appears to be reviving the OPEC. In the last 15 years, the share of OPEC in the global oil market has fallen from 60% to less than 40%. That has meant that it is the US and not Saudi Arabia that is now the swing producer of oil. Even if the OPEC is not able to recoup its central position, KSA would be keen to become the swing producer once again. That would be possible if a large number of shale companies in the US are bankrupted by keeping oil prices low for a long period of time.  With US bank funds drying up for shale it could be a keen battle, where users could be the winners.

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