Oil shock: what are the saudis and russians up to? | thearticle

What on earth are the Saudis and the Russkis up to? Are they (as the media suggests) at one another’s throats? Or are they conniving? Or is it a bit of both? I have known quite a lot of

Saudis over the years, and I have never met one who longed for anything other than a quiet life. That may be generational; those I have known tended to be those who remembered when Riyadh

was a sleepy town where one’s idea of a night out was to take the Chevy out of town, run a lead from the battery to the top of a dune, sit the family down, boil tea on a primus and watch

American soaps on a portable TV. For better or worse, this generation — I guess, epitomised by crown prince Mohammed bin Salman — is more aggressive, more ambitious, more aware of the power

that oil gives. And equally aware that petroleum is a wasting asset, and that it may not be quite the life-long annuity that everyone previously assumed. I haven’t known as many Russians,

but it is very clear that, for them, a predisposition towards confrontation is imbibed with mother’s milk — and latterly, that has meant a willingness to poke any kind of stick into

America’s eye. Given that Washington likes to think of Saudi Arabia as a sort of client state, that strange beast, OPEC+, was, therefore, always a tad unstable. And so it has turned out —

even though both Saudi Arabia and Russia share an interest in keeping oil revenues (if not prices) high, in delaying as long as possible the economic viability of non-fossil fuels and in

squeezing their joint nemesis, the US fracking industry. Still, it is a bit odd. If you believe the press (and most commentators), Riyadh and Moscow looked at the same problem, and came up

with diametrically opposed answers. In this case, my sympathies are mostly with the Russkis.  Even before Covid-19 got us all in a tizz, the International Energy Agency, the International

Monetary Fund and most of Wall Street had been downgrading oil demand forecasts for this year, and prices had been under steady downward pressure. The most commonly traded oil contract hit

$46/barrel, its lowest for a year, on February 26 on predictions of zero demand growth this year — that was down from $65 at the beginning of January. Now, as we are moving towards

coronavirus “peak panic”, demand forecasts have been slashed by at least another 2 million barrels per day (b/d), meaning that this will be the first year since the 2008 global financial

crisis that overall oil demand actually falls. Greta Thunberg certainly won’t be satisfied until there is blood in the streets, but — given the rapidly rising energy demands from

lower-income countries — this is quite a change. And I think even those forecasts may still be wildly optimistic. The OECD, for instance, has cut its global GDP forecast for this year from

2.9 per cent to 2.4 per cent — but that is still based on growth in China of 4.9 per cent, which seems pie-in-the-sky given that real-time indicators suggest Chinese GDP will actually fall

in the first quarter. So, what’s the sane response? For Saudi Arabia, the answer seems to have been to do what didn’t really work before, but to do it more aggressively. Apparently, the deal

it put on the table last week was to extend the existing 2.1 million b/d cuts that were due to expire at the end of this month — and to offer another 2 million. Of that, Riyadh’s posse

would guarantee 1.5 million, of which Saudi Arabia would pick up the lion’s share, while Moscow’s band of brothers would have to come up with 500,000. Russia’s answer was a curt _Nyet_ — and

one can sort of see its point. First of all, Saudi Arabia has only limited clout even within OPEC, none at all with what we loosely call Libya, and not much with Nigeria or Angola. Second,

based on recent history, any drop in OPEC+’s output will be immediately compensated for by a rise in US fracking. True, things aren’t great in the fracking industry just at the moment; 208

bankruptcy filings in four years doesn’t suggest a healthy outlook, and there is no doubt that capital is increasingly hard to come by. But the industry is still producing close to 11

million b/d, which isn’t chopped liver. Moreover, it has $40 billion of debt due this year, and the imperative for producers is, therefore, to keep pumping and for the banks to offer

forbearance just as long as there appears to be light at the end of the tunnel. Saudi Arabia was offering that light, which probably went down fairly well in Foggy Bottom, whatever the White

House might say. Russia’s view, however, seems to be that US frackers need $40/barrel to maintain a viable business and that this is a real opportunity to squeeze them so hard they pack it

in. My guess is that there are quite a few folks in Riyadh who agree with that. Who’s right? Well, in the past, the US frackers have always found a way to confound the sceptics and to keep

drilling. But it is getting harder. The Marcellus shale gas area, for instance, is all but played out, and other areas like Andarko and Eagle Ford are increasingly unproductive. True, the

industry is more efficient than it was, but environmental concerns can no longer be ignored and that is pushing up the cost base. There are anecdotal reports that much of the industry has

hedged its production through December, but the pain is going to show and this time, the casualty list may be pretty epic. But that’s if prices continue to fall. Saudi Arabia has, in effect,

said it is opening the taps, which, in the very short term, means an increase to over 10 million b/d from 9.7 million. In the longer term, who knows: 12 million is said to be sustainable.

As to what Russia can do, that depends on field maintenance, which is not Moscow’s strong point. But another 2 million b/d is quite feasible. At the present time, the most popular oil price

contract is selling at around $30.88/barrel and Brent at $33.42; they could still have a way to fall, which is going to put the US “tight” oil industry, and its bankers, under huge strain.

It is not clear that it will survive. Who else loses if prices do stay low? Well, the conventional wisdom says _Not Trump_: surely, Americans (and Brits) love the idea of cheap fuel. True,

but they don’t want a banking crisis either and that’s going to require quite a lot of fancy footwork from the US Federal Reserve and the other banking regulators. Plus, the US stock market

is already moving into “official” bear territory, with oils and airlines leading the way. That has huge implications for Americans’ pension plans and, therefore, for their willingness to

spend. Same over here: BP and Shell have already been murdered in the markets, and that means that every private pension pot has taken a hit. It also means that defined contribution and

defined benefit schemes are going to have a lot of ground to make up. In the end, no one wins, though the immediate discomfiture of the US oil industry will probably bring a smile to the

basilisk-like face of Vladimir Putin.