Over the weekend of 7 and 8 March 2020, Saudi Arabia began flooding the global market for oil by increasing their own production and reducing prices enough to bring them down by 25% the following Monday. The United Arab Emirates followed Saudi Arabia by announcing plans to boost oil output after the recent collapse of an agreement between members of a group known as the Organisation of the Petroleum Exporting Countries (OPEC+), to withhold supply and regulate prices.
Not since the OPEC oil embargo of 1973 has such a move been made to disrupt the economic stability of the fuel industry. Converse to the current scenario, however, by the end of 1974 the price of oil had risen nearly 400%.
March 9 this year also saw the biggest one-day decline in crude oil prices since the Gulf War in 1991 when the US led coalition experienced military success against Iraqi forces; as concerns about long-term supply shortages eased, prices began to fall significantly.
The current situation is sending shock-waves across financial markets that are already struggling with the fallout of the coronavirus outbreak. The spread of the virus was already putting a strain on transport and travel, with the United States banning travel from Europe and China following the World Health Organization’s announcement declaring it a pandemic, and the steep decline in oil prices is not helping. The fall in demand of 3.5 million barrels per day, is causing global concern.
The reason behind this economic war is Saudi Arabia’s disagreement with Russia’s oil industry. Saudi Arabia was in favour of cutting back oil production in lieu of depressed prices and demand, but Russian President Vladimir Putin refused to agree to the proposal. Russia is said to have argued the impact of the coronavirus on oil demand is still uncertain and that problems in Libya have already contributed to a reduction of up to 1 million barrels per day. This has led to a standoff between Saudi Arabia and Russia, in which they are flooding the market with oil in an effort to outlast and overwhelm each other.
The international trading classification of sweet light crude oil that serves as one of the two main benchmark prices for purchases of oil worldwide, Brent Crude, is currently selling for about $33.25 a barrel. West Texas Intermediate, the US benchmark, is close to $27.71 a barrel. There is growing concern that it will dip lower as Russia and OPEC members increase production while demand for oil declines continuously.
India is a large importer of crude oil, with over 80% of its requirements being met by imports. This means that there is huge potential for the country to benefit from this decline in oil prices, but given the economic slowdown due to coronavirus, it is still uncertain whether the lower crude prices can have a positive impact on India’s economy.
With regards to the oil industry, domestic producers such as Oil and Natural Gas Corporation Limited (ONGC) and Oil India Limited (OIL) will have lower profits. Currently, ONGC’s shares are at a 16-year low.
On the other hand, public oil marketing companies are expected to benefit as those involved in refining and marketing would get a boost from lower procurement costs.
In conclusion, the economic war has little to offer in terms of good reasoning. Lower oil prices and an unstable global economy threaten to undermine the Crown Prince’s plans for the Saudi Arabia’s diversification into an economy not based solely on oil, known as Vision 2030. The International Monetary Fund reckons the kingdom needs oil to fetch around $83 a barrel to balance its state budget.
The question, therefore, is how long Saudi Arabia and Russia can continue with this strategy, politically and economically unsustainable as it is. With the coronavirus affecting an already slowing global economy, an aggressive approach to this oil dispute between the two nations is a risky play for both, not to mention the implications of an international fallout. An immediate end to this growing crisis, followed by bilateral or multilateral talks, perhaps under the auspices of OPEC+, should be deemed necessary.
This blog was authored by Kartikeya Saigal.