Will an oil price war spark a global crisis?
The oil price suffered its biggest fall since the 1991 Gulf War after Saudi Arabia and Russia decided to bump up production at a time of reduced demand. Will there be more serious consequences?
“Now comes the oil shock,” says The Wall Street Journal. A “game of chicken between Riyadh and Moscow” has sent oil prices plunging and produced the worst day for many equity indices since 2008. Major oil producers led by the Saudis and the Russians, a grouping known as “Opec+”, have been cooperating to limit output and support crude prices since 2016. The Covid-19 demand slump saw Opec propose a new 1.5 million barrels per day (bpd) cut. That plan was rejected by Moscow, which has grown critical of an approach that it says only props up prices for US shale producers.
A nasty break-up
Rather than compromise, Riyadh retaliated. The Saudis slashed prices over the weekend in an all-out attempt to steal market share. The resulting “price war” could see the global market saturated with oil. Caroline Bain of Capital Economics predicts a “huge” global surplus of 3.2 million bpd in the second quarter.
The dramatic dissolution of the Opec+ alliance saw crude prices plunge by the most since the 1991 Gulf War on Monday. Brent crude fell 24% and is down almost 50% this year to trade at around $35 per barrel. US benchmark West Texas Intermediate had its second-worst day on record, losing 24.6%. Oil companies account for 10% of the UK equity market. The FTSE 100 had its worst day since the financial crisis on Monday, plunging 7.7%.
The International Energy Agency forecasts that demand will fall by 90,000 bpd this year, the first annual decline since 2009, says Andy Critchlow in The Daily Telegraph. Industry veterans fret that the “high-stakes game of roulette” between Moscow and Riyadh could see oil “tumble below $20” per barrel. The Saudis do not seem well-placed to win a price war: they need prices at $80 a barrel to balance their budget. Russia, with a more diversified economy, says it only needs $40.
The downsides of cheap oil
This high-stakes strategy is typical of Crown Prince Mohammed bin Salman, Saudi Arabia’s de facto leader, writes Julian Lee on Bloomberg. The prince wants to “drive oil prices down so far and so fast that Russia realises it made a terrible mistake”, but that is unlikely to work. As with the prince’s bloody intervention in Yemen, a supposedly short decisive blow could turn into a protracted conflict that does damage to all sides. The prince is “a risk taker... prone to impulsive decisions”, Greg Brew of Southern Methodist University told The New York Times.
Yet why is cheaper oil bad news? Historically, lower prices have been seen as a “net positive for global demand” as they boost consumer purchasing power and lower costs for businesses, says Jennifer McKeown of Capital Economics. Yet with coronavirus causing lockdowns and sowing fear, consumers are unlikely to rush out to spend. Oil-producing companies and nations are in for a serious budget squeeze. “What’s more, the price crash could put severe financial stress on the corporate bond market.”
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