Bluff gone wrong? - Understanding the Russia-Saudi oil crisis

The world markets were already sick with the demand shocks of Coronavirus. And out of nowhere came a deathblow to the markets leading to a complete “bloodbath” -In India that meant 170 companies hitting lower circuit and Mukesh Ambani losing $5 billion+ in a single trading session.

Unlike Covid-19, this was a man-made disaster, wilfully unleashed by the House of Saud onto the world. A series of meetings were scheduled from 5-March to 10-March with the objective of asking Russia to reduce its oil production by more than 1 million barrels per day in co-ordination with Saudi Arabia. Together, Russia and Saudi control 25% of the world’s crude oil supply. In today's post, we look at the history of oil production between the two countries, the changing dynamic after the entry of MBS, and how the two players stack up in this battle to the death.

How has Russia's and Saudi's oil production varied with time?

As we can see, Russia’s production is much smoother and has seen a consistent rise since its inception in 1991. Also, Saudi Arabia’s production is much more varying with sharp cuts and pumps. This is because of their large reserves of oil fields which they can extract at any level without major changes in capital costs. This meant Saudi Arabia acted as the swing supplier ensuring prices remained stable. But if we look at the above graph, since 2015-17 the variance in Saudi’s production is lower compared to the previous decade. Is there a specific reason?

What changes did MBS bring in?

Enter: Mohammad Bin Salman Al Saud(MBS), the crown prince of Saudi Arabia, who was the Defense Minister in 2015 when the House of Saud decided they would fare better if they went after market share instead of acting as the swing producer. This was in response to the booming shale production in the US, plunging the prices below $20 per barrel. This caused harm to the Saudi economy more than the US and then ended up back to cutting production in order to support prices. This can be seen in the yellow box highlighted above.

Here MBS comes to power and decides that Saudi Arabia is too reliant on oil-money and needs to expand to other sectors, but refrains from putting Saudi Arabia back into the swing producer stage. He wants a co-operation from OPEC+Russia to control the prices and was planning to achieve the same in Vienna’s meeting. But Russia didn’t co-operate as they were afraid of losing market share to Saudi (a justified fear as Saudi went after market share for 2 years vigorously) hurting them in the process. MBS and the House of Saud retaliated to this by increasing their own production into surplus, in an environment of low-demand caused by Covid-19 led to the closure of industries and transportation.

Is this a strategic masterstroke or a bluff gone too far?

But the world is not in MBS’s hand, and we only need to remember that Saudi Arabia relies almost entirely on oil for its budget. And as some analysts put it Saudi’s need oil at $80 per barrel to have a zero-deficit budget or they’ll end up using the central bank’s reserves. So any impact on crude oil will drain their central bank's reserves pretty fast, and as seen in the graph below, they’ve gone down and sat at $500 billion since MBS’s ascent to power.

Russia is used to austerity measures and they don’t rely on oil as heavily as Saudi Arabia. Hence, they called Saudi’s bluff. Now Saudi Arabia has 2 strategies to choose from - put in austerity measure and reduce their budget or play into Russia’s hand. For a strong leader like MBS, who crushed a coup attempt in the last week, and has a history of strongman-ship, the option of mutual destruction still sits on the table.

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About the Author: The post is written by our EZPP partner Jayadiya Sirasani with relevant edits and changes by our editorial team. Jayadiya is a graduate from IIM Calcutta, currently working with Accenture Strategy.