A Russian and a Saudi walk into an Austrian bar: The global oil war that nobody heard about

JUST in case a once-in-a-hundred-year pandemic and impending global recession were not enough to satisfy your pessimistic palette—last month saw a sudden oil crisis which in ordinary times would have undoubtedly been the most significant geopolitical development of the year.

But these times we are living in are anything but ordinary.

Given the skyrocketing unemployment rates and wild scramble for supplies caused by an unprecedented public health emergency, it is little wonder that consumers paid relatively little attention to the huge drop in fuel prices last month.

And for those who missed it, it’s quite the story; for it links a market in Wuhan, to a meeting in Vienna, to mom and pop gas stations in rural Kansas.

Our chain of events begins with China’s lockdown due to the COVID-19 outbreak, which wreaked havoc on global oil demand. The sheer volume of manufacturing and transportation activity suspended by the world’s biggest importer of oil caused instant panic amongst the world’s top oil producers—as they scrambled to protect their revenue streams.

In the first week of March, OPEC (Organisation of the Petroleum Exporting Countries)—a cartel occupied by the worlds largest oil producing nations—met in the picturesque Austrian capital of Vienna with their regular co-conspirator, Russia, in a mega cartel known as OPEC-Plus (not a streaming service).

The objective of this gathering featuring the who’s who of the oil world was clear: to reach an agreement on restricting the global oil supply and bring the market back into balance. The proposal was to decrease supply by 1.5 million barrels, with Russia accounting for 500,000 (or one third) of the cut.[1] Drastic as it may seem, such a drop was deemed necessary to place upward pressure on prices and restore some form of normality since the sudden halt in Chinese demand. As the unofficial leader of OPEC, the Kingdom of Saudi Arabia held a considerable share of power within the cartel, and their cooperation with the Russians was essential to stabilise a crucial market with severe global ramifications.

So, when the Russian Energy Minister Alexander Novak emerged from the meeting and encouraged producers to pump oil at will—pandemonium ensued.[2]

The price of oil dropped a massive 25-30% in a single session, having already declined throughout the first few months of 2020 as the COVID-19 response disrupted global demand. An incensed Saudi Arabia retaliated to protect the Kingdom’s market share by flooding the market with an extra 12 million barrels per day. Suddenly, the unilateral decisions of two major players in OPEC-Plus was sending economic shockwaves as far as the petrol stations suburban Melbourne to family businesses in ‘rust-belt’ America.

The irony almost beggars belief. Both Saudi Arabia and Russia use OPEC-Plus to restrict global supply and control prices—the pipe dream of many businesses in Western democracies where collusion and other such practices are strictly illegal. Yet, due to their own inherent selfishness, the two oil producers left the meeting in an environment of extremely unhealthy competition for themselves and the global economy more broadly.

The impact of a drop in demand combined with a sudden increase in supply is Economics 101—prices drop at astonishing rates with massive implications. Russian oil producers can bear a price of US$25.00/barrel while the Saudis are the world’s cheapest producers at just US$8.00/barrel which leaves the United States as the biggest casualty of this price war.[1]

In the last decade, the United States transformed from an oil importer with almost no influence within OPEC, to becoming the worlds largest oil producer thanks to the fracking revolution and emergence of US shale oil. However, in the United States, oil companies require a price of US$50.00 per barrel just to break even.[1] As the price of oil dropped lower and lower, the United States inched further and further into credit crisis territory. Many US oil companies are highly leveraged and occupy around 10% of the high-yield market.[1] Watching revenues vanish instantly sent markets tumbling with the impact sending shockwaves throughout global financial markets including the ASX.

Throughout West Texas, Kansas, North Dakota, Wyoming and New Mexico, small family-run oil businesses were plunged into financial uncertainty, and oil executives across the East and West Coasts pondered how to service their gigantic debt burden.

Ultimately, self-interest, geopolitical tension and the impact of COVID-19 all contributed to the crash. Neither the Russians nor Saudis were willing to shoulder the burden and cut production for the benefit of the entire cartel, each was waiting for the other to blink first—yet neither did. One would suspect that the Russian authorities would not be too worried by the detriment caused to US commercial interests, as rapid US shale development over the last decade occupied a market which was otherwise dominated from Riyadh and Moscow.

Within the cartel, the price plunge had a direct impact on the state, particularly in Russia where around half of all state revenue is sourced from oil.[3] In the United States, highly leveraged oil behemoths struggled to break even and service debt burdens, with devastating ripple effects for SME’s (small and medium-sized enterprises) in the Midwest and corporate tax receipts.

For us down under, the most immediate effect was (and remains) the lower price of unleaded at your local Caltex. But most householders would not have realised the impact on their superannuation, as ASX companies with oil interests lose more revenue within an already unprecedented economic crisis. It only goes to show, in todays globalised world, no state or citizen is truly immune from the shocks in otherwise foreign markets.

So, there it is, how a market stall in Wuhan called for a meeting in Vienna, the consequences of which left small businesses in rust-belt America reeling.

What a time to be alive.

[1] The Age (2020) ‘The Short Squeeze: Slipping on the oil price’, 12 March. Available at: https://www.smh.com.au/business/markets/the-short-squeeze-slipping-on-the-oil-price-20200312-p549bt.html (Accessed 6 March 2020)

[2] Raval, A. Brower, D. and Sheppard, D (2020) ‘Russia breaks OPEC oil alliance as it takes on US shale’ Financial Review. Available at: https://www.afr.com/world/europe/russia-breaks-opec-oil-alliance-as-it-takes-on-us-shale-20200308-p547zv (Accessed 6 March 2020)

[3] NPR (2020) ‘Episode 978: Coronavirus, Oil, and Kansas’, 11 March. Available at: https://www.npr.org/2020/03/11/814529252/episode-978-coronavirus-oil-and-kansas (Accessed 6 March 2020)

Image by Zbynek Burival on Unsplashed