Oil Price War 4.0 Series Part 5 – Putin’s Masterstroke

Despite misplaying his hand horribly, and rather remarkably being outsmarted by both Saudi Crown Prince Mohammed bin Salman (MBS) and U.S. President Donald Trump, Russian President Vladimir Putin made virtue of adversity by agreeing to the historic OPEC+ deal finalized on April 12. This has allowed him to relay the groundwork for his strategy to win the price war against the U.S. shale industry.

Putin’s strategy

As discussed in Clash Of The Oil Titans, the second article of this series, rapid increases in U.S. oil and natural gas production are interfering both directly and indirectly with Putin’s global and domestic ambitions — expanding Russian power and influence abroad and securing his position as president through the year 2036. That is because it reduces his country’s budget and export revenue and allows the U.S. government to use financial and economic sanctions as a tool of foreign policy against the petroleum industries of its foes, including Russia’s.

As discussed in the first two articles of this series, by ending over three years of Saudi-Russo co-operation at the OPEC+ meeting on March 6, and intentionally provoking MBS in the process, Putin instigated an oil price war to cause massive, permanent damage to the U.S. shale industry.

Kremlin officials have since said Russia could withstand oil prices in the US$25 to US$30/bbl range for six to 10 years, suggesting Putin’s strategy was to slowly destroy the U.S. shale industry over the course of several years, possibly to keep Trump and his potential successor from imposing tariffs on oil imports to protect the industry — referred to as a “distinct possibility” in Major Wildcards, the third article in this series.

Strategy gone awry

However, Putin severely underestimated Saudi Arabia’s reaction to his price war and the amount of demand destruction being caused by the novel coronavirus pandemic. This put not just the U.S. — and Canada’s — oil industry at risk, but the Russian and global industries as well, with the threat of negative oil prices as the world’s crude storage tanks rapidly fill. The extreme rate at which the global oil landscape changed significantly increased the likelihood of the Trump administration imposing tariffs on oil imports to protect the U.S. industry.

In the second article of this series, I indicated that Russia got more than it bargained for from MBS. Putin may have wanted Saudi Arabia to open the taps to push oil prices down into his targeted range, but on the weekend following the failed OPEC+ meeting Riyadh offered record discounts on the official selling prices for its crude in April, with especially large discounts for Arab Light crude in Europe to challenge Russian sales of Urals blend in the region in an apparent attempt to force Russia back into the OPEC+ fold. This precipitated an oil price crash on March 9, the largest daily decline since the beginning of the Gulf War in 1991.

At the time, the Kremlin indicated its oil producers were planning to increase their output by 300,000 to 500,000 bbls/d in the coming months, but Russian Energy Minister Alexander Novak retracted this threat on April 2, likely out of necessity. A Russian producer reportedly offered a Belarus refiner a shipment of Urals blend for less than US$10/bbl in mid-March, and its offer was refused, with the company’s normal client citing cheaper Saudi oil as the reason.

On April 5, Trump reiterated his threat to impose “very substantial tariffs” on oil imports into the U.S. to protect the domestic industry if OPEC+, led by Saudi Arabia and Russia, did not implement substantial output cuts, something he indicated was in the works a few days before.

In terms of the threat the supply glut was causing the global oil industry, especially the U.S. industry, with worldwide crude storage capacity likely to be exhausted by the end of May, OPEC secretary general Mohammad Barkindo possibly said it best at the virtual G-20 oil meeting on April 10.

"There is a ghostly spectre encircling the oil industry," Barkindo told the G-20 energy ministers.

"We need to act now, so we can come out of [the] other side of this pandemic with the strength of our industry intact."

Putin’s masterstroke

Putin agreeing to massive output cuts along with the other 23 OPEC+ members despite the failure of other major oil producers such as the U.S. to agree to concrete cuts under the auspices of the G-20 does not signal capitulation and the end of his price war, but merely a tactical retreat. The deal protects Russia’s oil industry from the worst of the pandemic-induced demand destruction, keeps the U.S. in the international oil game, and should allow Putin to manipulate oil prices into his preferred price war range following a few months of weaker than desired prices.

Russia may have built a war chest to fight its oil price war, but oil and gas is one of its two core export industries along with armaments, while its economy is less than a tenth the size of the U.S. economy based on the ruble-dollar exchange rate and the per capita income of Russians is less than a fifth of Americans. Putin and the country simply cannot afford single digit or lower prices for its crude oil for an extended period.

In addition, keeping the U.S. in the international oil game is imperative for the success of Putin’s price war. As discussed in the third article of this series, a Fortress America would provide the Russian leader with a partial victory, as it would keep the U.S. from becoming a significant net-oil exporter, but it would negate the possibility of substantial reductions of American crude oil production.

The U.S. Energy Information Administration (EIA) is forecasting the country’s crude oil output to decline by 1.7 million bbls/d to 11.1 million bbls/d between December 2019 and December 2020, while U.S. Energy Secretary Dan Brouillette said the decline could be between two million and three million bbls/d over this period at the G-20 meeting.

Finally, the new OPEC+ agreement may look great on paper, but it should be easily manipulated by Putin once the worst of the COVID-19 pandemic has passed, especially if Joe Biden beats Trump for the U.S. presidency in November. The deal reduces crude oil production by 23 per cent for each member of OPEC+, with the exception of Mexico, for a total of 9.7 million bbls/d in May and June, 7.7 million bbls/d from July to December, and then 5.7 million bbls/d from January 2021 to April 2022.

But a two-year OPEC+ crude production agreement is a political agreement, not a practical one, as no one knows what global oil supply and consumption is going to be over the next two years under normal circumstances, let alone these extraordinary times. Whether by hook or by crook, the deal should leave Putin with plenty of opportunity to keep crude prices within his preferred price war range in the coming years, especially with global oil inventories at elevated levels.