Updated: Aug 5, 2020
Maharashtra National Law University, India
Saudi Arabia, a rich oil producer and exporter of the petroleum products in the Middle East, has recently been witnessed to enter into an oil price war with a superpower, Russia. The reason given by them is simple; the ongoing pandemic has slowed down the global economy bringing it to a standstill, thereby reducing the overall consumption of petroleum-related products. This resulted in the overall fall in the demand of petroleum resulting in the reduced oil prices, thereby causing a major setback to the cartel of OPEC. The members had agreed on some cuts in the last financial year and were desperate to continue with it in 2020 as well but Saudi Arabia, which is at the epoch of the cartel and the oil-producing nations proposed to extend it for the whole financial year 2020 and further suggested to remove 1.5 million barrels per day (Mbpd) from global production and holding Russia accountable for 1/3rd share.
The need for the USA intervention arose when Russia and Saudi demanded the US to cut its domestic oil production proportionately to which the US didn’t agree and instead proposed an alternate that despite the opposition he may impose tariffs on the imported oil, thereby making it expensive and discouraging the US population to consume it. The reason behind this can be traced back to the recent years when the US became the world’s largest oil-producing nation, surpassing Saudi Arabia and Russia. The reason that the US gave for imposing the tariffs on the imported oil can be attributed to the fact that it needs to protect the domestic industries and the interests of the workers. If no quotas or trade barriers are employed then there would be a competition within the local markets and the consumers would prefer those goods that best suits their interests. In that scenario, the local industries would suffer a major setback and would be forced to shut down their operations.
The Trump administration at present has no intention to impose the tariffs but he has clearly mentioned his intention that he won’t mind in exercising this option if the price war continues between the nations. Since every coin has two sides, the critics have highlighted the darker side of this type of tax imposition.
They have highlighted that since most of the oil-producing industries operating in the US depend on the crude oil from abroad, these tariffs will unnecessarily put a heavy burden on the companies’ purchasing policies and force them to purchase the same. The leaders of the shale industries have urged the US President to tackle the situation and address the problems that they may face with the excess supply of oil and the comparatively low demand. The need to address the issue further aggravated when the US crude grade West Texas Intermediate, reached its all-time low at the beginning of the year, trading around $23 per barrel, down from $60-something per barrel. Trump reiterated that the oil prices should be high enough to support the domestic workers and the drillers and at the same time demanded that once the pandemic is over and the global economy starts recovering, the price should be lowered to sustain the world population as all the major activities depend on the petroleum and its products. Trump administration also hinted at a possibility that if the production continues at the current rate, then it may lead to storage problems and a possibility may arise that the oil fields may have to stop their operations permanently.
Significance of this Development
The reason behind Trump’s interference in the price war was to secure and create a favorable market scenario for the US shale industries by cutting the production. The declaration of the imposition of the tariffs made the local crude oil supplies to gain a 24% hike in the prices, making the US crude futures to rise by 2% and enabling the US to devise and adopt a strategic plan to purchase around 30 million barrels of crude oil for the month of June, to be stored in Strategic Petroleum Reserve, thereby, helping the US shale companies to bypass the collapse in the international oil market arising out of a result of the price war between Moscow and Riyadh. The US senators have been constantly urging the Ambassador for Saudi Arabia to look into the matter after Russia rejected the role of a third party in the ongoing crisis. The senators have reminded the Arabian authorities to look into the past and recollect the role of US in the development and the protection of kingdom from Saddam Hussein’s regime, the First Gulf War where the US stood by its side and fought for its cause. It clearly expresses its intention to continue the same relation with the royal family in the future as well without any feeling of ill-will and that the time has come for the country to justify its friendship towards the States by ending the price war and bringing the global oil market back on its track. The US President and the Saudi King are looking at a way forward to establish the world’s newest oil cartel so that they be in a better position to influence the market in a way favorable to them.
The Secretary of the State of US in the bilateral talks with the Crown King highlighted that being a leader of top-notch energy nation and as an important member of the G20, the country carries with itself the high opportunities to reassure the global oil markets and stabilise the financial and derivatives markets during the pandemic period when most of the nations are going through a phase of mandatory lockdown.
The concerns laid down by the Saudi Energy minister himself highlighted that the if the current pandemic continues to doom the world economy and the country continues to produce the oil and its products with the same pace, it may go bankrupt within 3 to 4 years which will ultimately benefit Russia. The incapability of the Saudi industries to honour its contracts will provide pace to the Russian industries and its allies, thereby reducing the competition in the same set of arenas and enabling Russia to acquire control of all the major oil-producing countries in the Middle East, adding to the woes of the US shale industries.
Details about the War
The Price war that started between Saudi Arabia and Russia was in the wake of ongoing global pandemic i.e. Corona Virus, that brought the world economy to its knees and has affected all the sectors of the economy be it legal, political, social, etc. The Saudi Arabia which is considered to be as a hub of the petroleum-related products including crude oil wanted the allies of the OPEC cartel including Russia, to bear the loss of around 33% caused to the Gulf Countries because of the decreasing consumption of the oil in the globe as the nations have suspended the flights, put a restriction on the intercity or interstate travels unless extremely necessary, suspended the delivery of cargo except for the essential goods, etc.
The shock came on 8th March 2020 when Saudi Arabia unexpectedly started offering substantial discounts and slashing the prices for its customers in US, Europe and other such developed economies so as to create a favorable market for its oil despite the pandemic. This not only caused a major loss to the US petroleum markets and the oil derivatives but also had a substantial effect on the stock markets with most of the companies hitting the lower ceiling. The announcement made by the Saudi and Russian authorities to further increase the production of oil by at least 300 thousand and 2.6 million in addition to the state-owned Saudi Aramco to pump a million oil barrels, further aggravated the situation. Infuriated by the fact that Russia was unwilling to co-operate in reducing the global oil production, the nation increased the supply of the petroleum products causing a major setback to the Ruble, increasing the value of imports and hence, giving rise to the inflation. The situation became even more tensed when Russian Ruble fell drastically against the US dollar reaching its all-time low over a span of 4 years. The overproduction with a negligible amount of demand led to a drastic fall in the prices of petroleum products, concerning the US and making it to step in and taking some diplomatic actions in the form of imposing tariffs, trade barriers, quotas, taxes on the crude oil imported from Saudi Arabia to protect the local industries. So, in order to assuage the tension between the nations and in good conscience to give out a message that the world stands united against COVID-19, the OPEC cartel and its allies after a month of negotiations, finally agreed to cut the global oil production output by 23% for the month of May and June temporarily.
How did it start?
The COVID-19 that started from China’s Wuhan province, has till date claimed around 1 lakh lives and left several infected. The precautionary measures taken by various nation-states include the complete shutdown of some prominent cities of the world having a severe impact on the economies. The decreased oil prices raised the concerns of the developed nations such as US, UK, Europe etc. urging the Middle East to cut the production of the petroleum in order to secure the interests of the local shale and crude industries. The countries also highlighted the concerns that if the production isn’t halted within a reasonable time, then there would be a scarcity of the oil storage which in turn will cause a huge loss and would add to the woes of the petroleum industries as these would be compelled to shut their operations, further having a major impact on the economies, especially of the Middle East countries as drilling and oil extraction activities constitute around 80% of their GDP. Other developed nations will also be affected as, if the industries in the Middle East find themselves being dragged into a situation of bankruptcy, they would shoot up prices and impose higher export duties along with other tariffs to such an extent that it would be very difficult for the nations around the globe, especially the developing nations, whose most of the activities in the economy are dependent upon the petroleum and its products, to even import the oil, having an indirect impact on the GDP of these economies as well. The Saudi-Russia price war started when the cartel in the 178th extraordinary meeting of its members and the allies, it arrived at a decision to cut the oil production by an additional 1.5 million barrels per day in the wake of ongoing pandemic and appealed to all its members to abide by its decision. But due to the lack of consensus between the OPEC members and its allies, especially Russia, and the latter exiting from the collision, there was a major plunge in the oil prices almost by 10% in the Asian countries. This led to the prices hitting the worst of all times since 1991 during the Gulf War, plunging almost to around 24%, creating fear among the US industries.
The situation aggravated with the time and infuriated Kingdom started overproducing the petroleum products, directing all the industries including the Saudi Aramco. This necessitated the need on the part of the US to step into to tackle the ongoing crisis and control the prices.
Russia highlighted that the cuts in the oil production were more favorable to the US as being the largest oil producer it wasn’t made to bear the burden regarding the main concerns raised by Russia were regarding the share of burden proportionately by all the major oil producers including the US. Russia was provoked to disagree with its Saudi counterpart in order to retaliate against the US shale industries, as earlier in February 2020, the US imposed sanctions on the Russian oil-producing company, named Rosneft for transporting Venezuelan oil, what the US believed was the support of Maduro dictatorship in the country. So, after month-long negotiations and deliberations the, three nations finally agreed for a temporary cut in the global oil production standards by 23%.
The probable way forward
The OPEC cartel and its allies, dubbed as “OPEC+”, are willing to cut the production only if the other major oil producers join them, in order to bring the market prices down and restore a balance between the demand and supply. Saudi Arabia is often willing to collaborate with most of the US states to manage and control the prices in future if any such pandemic hits the global market. But the experts have often pointed out that “OPEC+” cartel can’t sustain for long because of the following reasons:
The notion that both the oil-producing and oil-consuming nations can come on the same pedestal is against the economic interests of both. The major oil-producing states have formed OPEC while an association namely International Energy Agency has been formed by the consuming nations but the main problem lies somewhere in between where the countries such as the US, which has recently acquired the status of being the top oil producer in the globe isn’t a part of the OPEC cartel lacks the form of dialogue with these nations, thereby creating differences and hampering interests of both the sides.
Even if a common platform is agreed upon for all the major oil producers, it would create a problem for those economies where the production of petroleum products isn’t regulated by the state but by the private firms. So, a decision taken against these firms might create problems.
The countries where the demand and supply are determined by the market forces without any government intervention also pose a threat to the infant shale industries. Even though price collapse may be painful for most of the companies by driving them out of the competition, it will help to sustain the stronger industries with good financial statements and records to dominate the market and in turn, will help them to recover the prices.
Every nation depends on every other country for the fulfillment of its needs and interest of the population as no country is self-abundant and self-sufficient in all the resources. The Global Economy operates and functions on this principle of dependence on each other. The price war which broke out is a clear-cut example of how the non-cooperation on the part of a developed country may cause a substantial loss to all the economies of the world, be it developing, developed or under-developed. The overproduction of any of the commodity can cause a substantial loss to its own as well as the other nations’ GDP. The resultant reduction in price can also bring a situation of recession and slow down the economy to an extent that in order to recover, it may have to shut the operations and lay off workers further adding to the woes and creating a situation of unemployment. The ruckus and chaos that the COVID-19 has created had already made the World Economy suffer by bringing to a standstill and causing a situation of predicted recession. Thus, to avoid such a situation, it is inevitable that each and every nation acts wisely and co-operate in the international arena.