Oil Price War 4.0 Series Part 2 – Clash Of The Oil Titans

In the first of the Oil Price War 4.0 series, it was argued in a general sort of way that Russian President Vladimir Putin’s price war would likely be longer and deeper than the three previously started by Saudi Arabia.

In this article, I will delve into the events showing Putin instigated this price war, and Saudi Crown Prince Mohammed bin Salman (MBS) has simply served as his “useful idiot,” in KGB parlance. I will also discuss the reasons Putin’s timing for destroying the U.S. shale oil industry — the goal of his price war — is impeccable, and why the Russian leader feels the industry is such a threat.

I will end by focusing on the personalities of the three main combatant — Putin, MBS and U.S. President Donald Trump — and how they could contribute to a longer and/or deeper price war through their policies and actions.

Putin’s price war

Putin instigated the latest oil price war by ending over three years of Saudi-Russo co-operation at the OPEC+ meeting held at OPEC headquarters in Vienna on March 6, intentionally provoking MBS while he was at it.

As reported by Bloomberg, Russian Energy Minister Alexander Novak arrived 16 minutes late for the meeting scheduled to start at 10 a.m., and promptly told the gathering his government was unwilling to support the 1.5 million bbls/d of additional production cuts — one million bbls/d by OPEC members and 500,000 bbls/d by non-OPEC supporters — Saudi Arabia was pushing to counter demand destruction caused by the spreading novel coronavirus pandemic.

For the next five hours, Novak refused to budge on his government’s position, of extending existing OPEC+ cuts an additional three months to the end of June, while repeatedly expounding on the Kremlin’s rationale for its decision. Propping up prices would simply be another gift to the U.S. shale industry, an industry that had already added millions of bbls per day of oil to the global market, while low-cost Russian and Arab oil was being shut in. Novak repeatedly said the time to squeeze the Americans was now.

Bloomberg also reported that MBS wanted to speak to Putin by telephone while the meeting was in progress, in an attempt to persuade the Russian leader to adjust his government’s bargaining position, but Putin’s spokesperson explicitly said he had no plans to get involved.

Speaking to reporters immediately after the failed meeting, Novak said as of April 1, when the previous agreement expires, the 24 OPEC+ members would no longer be constrained by production limits and each could produce as it sees fit.

Shale threat

The U.S. Shale Revolution is posing a multifaceted threat to Russia, with rapid increases in U.S. oil and natural gas production interfering both directly and indirectly with Putin’s global and domestic ambitions — expanding Russian power and influence abroad and securing Putin’s position as president for the foreseeable future. Rapid and large increases in U.S. output have directly contributed to lower budget and export revenue for Russia, due to lower prices and market share for gas, and primarily lower market share for oil because of OPEC+ supply constraints propping up crude prices the past three years.

On the indirect front, the U.S. Shale Revolution has helped shift global oil and gas markets from scarcity to plenty, which in turn has allowed both the Obama and Trump administrations to use financial and economic sanctions as a tool of foreign policy against the petroleum industries of its foes. For example, the Trump administration has ramped up sanctions against Russian allies Iran and Venezuela over the past two years, in an attempt to bring about behavioral change, if not regime change.

In addition, both the U.S. and the European Union imposed sanctions against Russia for its annexation of Crimea in 2014, as well as its support of Russian secessionists in Ukraine as a whole, including sanctions specifically targeting Russia’s oil and gas industry.

As mentioned in the previous article, recent U.S. sanctions against Russian companies and projects — a Rosneft subsidiary for selling sanctioned Venezuelan oil; and construction companies in an attempt to stop work on the nearly complete Nord Stream II gas pipeline project from Siberia to Germany — appear to have been the final straw for Putin when deciding to continue his country’s co-operation with OPEC+ or not. Adding salt to the wound, the U.S. has been pressuring European countries to purchase American LNG instead of piped Russian gas.

It is important to note that Putin’s oil price war should negatively impact not just U.S. oil production but natural gas production as well, because associated gas production has been driving growth with North American gas prices below US$2/mmBtu.

Impeccable timing

Putin has proven himself a political and geopolitical master since becoming leader of Russia roughly two decades ago, and the timing of his oil price war for inflicting maximum damage on the U.S. shale industry appears to support his master status.

The COVID-19 pandemic appears to have supported Putin’s price war in three ways: by giving him an excuse to end OPEC+ co-operation; by providing additional downward pressure on oil —and gas — prices; and by absolutely demolishing valuations for oil and gas stocks, making it even more difficult for them to source outside capital to ride out the downturn.

The U.S. shale industry was able to survive the Saudi-instigated 2014-16 oil price war partly because of a near endless supply of credit and equity supplied by private equity, investors and banks. This time around, the heavily indebted industry is out of investor and banker favour, with drilling projects often unprofitable, partly due to rock-bottom natural gas prices, and this was even before the recent oil price collapse.

The U.S. shale industry has shifted into survival mode since the price of West Texas Intermediate (WTI) collapsed to roughly US$30/bbl on March 9 — the first trading day following the ill-fated OPEC+ meeting — slashing capital spending budgets, idling rigs and cutting staff to do so. Most shale producers had budgeted for WTI at between US$55 and US$65/bbl in 2020.

Based on Rystad Energy field-by-field data, only a handful of the hundreds of U.S. shale producers can make a profit from new wells with WTI at US$31/bbl —let alone US$25/bbl or US$20 or US$10. Combined with a lack of access to outside capital, this would appear to suggest numerous companies are ripe for bankruptcy or restructuring, barring U.S. government intervention.

Personality clash

The cunning old fox Putin appears to have played proud and impetuous MBS to get him to open Saudi taps to help tank global oil prices, but the Russian leader is getting more than he bargained for. The young Saudi leader is continuing to ramp up his Kingdom’s shock-and-awe strategy, with the support of regional ally United Arab Emirates (UAE), to push oil prices even lower than Putin would prefer in an attempt to force Russia back into the OPEC+ fold.

On the weekend following the failed OPEC+ meeting, Riyadh slashed its so-called official selling prices, offering record discounts for its crude, with especially large discounts for Arab Light crude in Europe to challenge Russian sales of Urals blend in the region. This precipitated the oil price crash on March 9, the largest daily decline since the beginning of the Gulf War in 1991.

The Kremlin responded by saying Saudi actions and the resulting oil price decline were pretty much as expected, and Russia had the financial resources to cover budget shortfalls with oil prices in the US$25 to US$30/bbl range for six to 10 years — Russia has also indicated its producers are planning to increase production by 300,000 to 500,000 bbls/d in the coming months.

In an apparent attempt to push oil prices below this range, Saudi Arabia has since announced plans to sell 12.3 million bblsd for the remainder of the year, an increase of 2.6 million bbls/d from March, and boost crude oil productive capacity by one millions bbls/d by the end of the year.  The UAE has announced plans to increase crude sales by one million bbls/d to over four million bbls/d for the remainder of the year, and to accelerate plans to increase its productive capacity by roughly one million bbls/d as well.

The large supply increases from Saudi Arabia, UAE and less so Russia, as well as demand decline caused by the COVID-19 pandemic, will push oil prices below the Kremlin’s preferred range, but it is highly doubtful that this will force Putin to back down on his price war for two reasons.

Putin prides himself a strongman, and numerous times in the past has been willing to pay a price for what he feels best serves Russian interests, and he knows MBS is playing from a weak hand. As discussed in the previous article, Russia is far better positioned to survive a prolonged and deep price war than Saudi Arabia.

In an attempt to protect the U.S. shale industry, which has the potential of prolonging Putin’s price war, Trump joined the fray on March 19. He said, “at the appropriate time, I’ll get involved,” while promoting a 77 million-bbl build of the U.S. Strategic Petroleum Reserve (SPR). In the process, Trump was credited with providing impetus for the largest daily percentage point price increase in WTI history —24 per cent to US$25.28/bbl.

To date, Trump has not actually done much to directly support the U.S. shale industry. But one extreme policy action his administration could undertake would likely bring an early end to Putin’s price war. This, along with two other wildcards, will be discussed in the next article in the series.