Clash of the (Oil) Titans
By: Mehrunisa Qayyum and Mark Nabong
“When elephants fight, it is the grass that suffers.” — Kenyan Proverb
A price war that broke out between Russia and Saudi Arabia back in January has hit the proverbial gas pedal in the wake of the COVID-19 crisis. Saudi’s neighbor to the north, Iraq, relies on oil sales to fund 90 percent of its state budget. According to our analysis of rentier economies (oil countries relying on oil), we lay out the biggest oil producers, exporters, and more importantly, those producers most adversely affected regarding their GDP dependence on fluctuating oil prices. (PITAConsumer used Python to concatenate data sets and replicate code for analysis, which is available on GitHub.) At this stage, is it worthwhile for the US to attempt to intervene?
The conflict is not without risks to the belligerents. Saudi Arabia needs a crude oil price of $82/barrel in order to balance its books; any lower and the Kingdom will need to borrow money or draw down reserves to cover oil sales that are, effectively, at a loss. Russia may be better prepared to withstand oil shocks than Saudi Arabia, as the IMF believes that Moscow breaks even at $42/barrel. The current price, however, still results in a massive loss in revenue for Russia, and both countries will be cutting their noses off to spite their faces if the price war continues for long.
Rentier Economies: High-Income Countries
As seen above, Russia is not in the category of “Rentier Economies Relying on Oil Profits to Fuel GDP”. Yet lower oil prices still negatively affect the Russian economy as a large oil producer and exporter. Russia is adversely affected in its daily spending while hitting its resources. Although Russia is in a better position to deal with its low prices, the oil crash, compounded by the pandemic, is expected to cut 3 percent of the country’s GDP growth this year.
In contrast, Eastern Mediterranean countries (encompassing West Asia and North Africa) The following are rentier economies in order of most dependent: Iraq, Libay, Kuwait, Saudi Arabia, United Arab Emirates, Bahrain and others in the region largely depend on oil production to fulfill their social contracts and subsidize education, health, and infrastructure programs.
Due to low prices, these countries — in particular Saudi Arabia and Iraq — face running fiscal deficits if they do not recalibrate their budgets by incorporating fiscal austerity measures. But,Saudi Arabia and a few other nations in the region are capable of churning profits even if Brent prices fall as low as $10 a barrel.
Middle-Income Countries Stuck in the Middle
Meanwhile, energy demands fall back as middle-income countries, like Lebanon, are stuck in the middle: Protests broke out over its currency crisis, high food prices, and general displeasure with crony capitalism. Adding insult to injury, Lebanon’s attempt to capitalize on off-shore hydrocarbon efforts failed in late April. Moreover, the horrendous health effects of COVID-19 are accompanied by a global drop in demand for oil as factories across the world stay shuttered, and this has exacerbated the fall in oil prices.
Lebanon may serve as a microcosm of what may come if the U.S. prioritizes energy security over food and jobs security. Before oil prices started to drastically fall, the World Bank already forecasted that the 30 percent living under Lebanon’s poverty line could spiral up to 50 percent. Higher-income countries are not immune: by April, 26 million Americans had filed jobless crimes since COVID-19 forced massive furloughs and layoffs.
Oil Exporters Most at Risk
Certain oil exporters are more at risk, like Saudi Arabia and Iraq. Lower gas prices are the last thing on protestors minds as social-distancing and shelter-in-place measures stifle the energy demand. Brent crude oil traded at $16.2 a barrel on April 29th, a drop from the Dec. 31, 2019 price of $63.35 a barrel. As higher-income countries are climbing out of the pandemic, crude oil prices slowly climb up too at $38.68. OPEC attempted several emergency meetings because the triple threat of a pandemic, a supply surge, and a Riyadh-Moscow row pushed prices into the negative — a devastating first. How will this help the 42 million Americans who have filed jobless claims?
Moreover, how does one reconcile President Trump’s insistence to re-invite Russia back into the G-7, given other security and diplomatic challenges?
US Risk: Exporter, Consumer, and Dealmaker?
The US is both a competitor in crude oil production and a consumer of oil from Russia and Saudi Arabia. The US is also subject to wild volatility in its financial markets at the moment. US oil prices are already causing headaches for American companies, and falling oil prices are not going to help the US economy. Despite what the American President says into the cameras, US consumption, whether consumer or industrial, is not due to rise to take advantage of the lower prices given the health risks posed to employees by COVID19. A shuttered factory due to pandemic will not reopen simply because gasoline is cheaper.
The question remains about whether it is worthwhile for the US to spend diplomatic capital to prevent two competitors from kneecapping each other. And it seems counterproductive to American interests to do so between Russia and Saudi Arabia. In terms of oil pricing, helping two competitors set aside their differences is not a good idea for a third competitor, the USA.
President Trump has urged the Kingdom to be the bigger man (and acknowledge that they are in a tighter financial spot) and back down from a price war.
Perhaps the best strategic option is to let Saudi Arabia and Russia bash each other for a bit as advanced and developing economies deal with the socio-economic challenges posed by the pandemic, such as food security. The lesson learned from the EU-Russia oil price conflict of 2009 is telling: the US should let the belligerents joust each other rather than intervene. The American economy will be better served in the long term by reducing American dependence on foreign energy sources and the unpredictability of the international oil barrel prices.