By Irina Slav
Two months ago, Russia said no to Saudi Arabia’s proposal for deeper oil production cuts. It was enough to start a price war that, coinciding with the Covid-19 pandemic, wiped out billions in oil revenues for both Russia and Saudi Arabia while forcing them to enact even deeper cuts than previously discussed.
Some say the price war was never about Saudi Arabia and Russia. They say it was about U.S. shale. If that is accurate, what happens when the U.S. shale patch regains enough strength to start ramping up production again?
It might sound premature to talk about production ramp-ups with West Texas Intermediate still below $40 a barrel and likely to stay below this crucial mark for a while. But eventually, prices will hit the mark: shale producers have cut a solid chink of their output, demand is improving, and not least, bankruptcies are already underway with more to come. In fact, as many as 250 U.S. shale companies could go under, according to Rystad Energy, unless prices improve markedly and quickly.
Gulf-focused business journalist Frank Kane wrote for the Arab News that the next price war is just a few dollars per barrel away. These few dollars would motivate producers to start increasing their production.
“It would make no sense at all for Saudi Arabia to continue with its market-changing cuts, which are exacting a big price in terms of lost revenue, if the U.S. was swamping the world with oil again,” Kane wrote, adding that, “The battle for market share — with the Kingdom turning the pumps full throttle again — would be back on.” Saudi Arabia recorded a budget deficit of $9 billion for the first quarter of the year, with revenues down 22 percent during the period on the back of the oil price slump. Aramco’s profit for the quarter fell by 25 percent. The Kingdom started issuing bonds on the international market to stabilize its finances as it bled foreign reserves at the fastest rate in 20 years, according to Reuters, as it fought the double blow of low oil prices, weak demand, and the Covid-19 pandemic.
Meanwhile, Russia reported a budget surplus for the first quarter, albeit a modest one, at 0.5 percent. It maintained the surplus in April as well, but now it seems that the pandemic has started to take a toll, with Finance Minister Anton Siluanov telling local media that the government planned to increase borrowing and delay some national-scale projects until the economy recovers. The minister forecast a 5-percent GDP decline for the year thanks to oil price developments and the pandemic.
Economically speaking, the immediate outlook for the U.S. economy is grimmer than that for Saudi Arabia or Russia, with the second-quarter GDP seen by some as posting a double-digit decline, and a hefty one at that, at up to 40 percent. The U.S. oil industry is not such a big part of the United States’ GDP as it is for Russia or Saudi Arabia, but unlike Russia or Saudi Arabia, the U.S. oil industry can hardly rely on government aid. In fact, the American Petroleum Institute has spoken against such aid.
So, let’s say a couple of hundred U.S. shale drillers go bust because of the prolonged price depression. This will coincide with gradual demand improvement as lockdowns go away, and barring a second wave of Covid-19 infections, this demand improvement will push prices up. As this happens, the surviving shale drillers, most of them debt-laden, will have no choice but to start pumping more.
What will Russia and the Saudis do then?
Russia has said it could live on cheap Brent for years as long as “cheap” means no less than $40 a barrel. Saudi Arabia needs twice that to break even. But does it need to break even? There are many countries living in comfort with budget deficits, and the United States is—or was prior to the pandemic—by far the best example. Saudi Arabia’s Finance Minister recently said the economy of the Kingdom was solid enough to withstand the effects of low oil prices. If this is true, then it would probably be solid enough to endure another round of maximum production, which would be the only response to rising U.S. production that would make sense for Saudi Arabia.
Of course, there is an optimistic scenario: demand improves so fast that everyone is happy with prices. Indeed, according to Russia’s Energy Minister, supply and demand could rebalance within two months now that production cuts have reached as much as 15 million bpd. This, Alexander Novak said, means that the current supply surplus has shrunk to 7-12 million bpd.
Now, all we need is to wait and see how quickly demand recovers, because there are doubts, including within the oil industry, that it might never recover to pre-crisis levels.