On 18 March, U.S. crude oil prices fell to their lowest level in 18 years. The following day, momentarily distracted from their hype of the coronavirus pandemic, pundits and analysts reminded us again that low oil prices are the result of Saudi Arabia instigating a price war with Russia. And again, the culprit named was Mohammed bin Salman, Crown Prince of Saudi Arabia. Among his motives, they claimed, is hobbling the fracking industry that has ended American dependence on Middle East oil. Now, let's examine the real backstory.
Weeks before a scheduled meeting of the Organization of the Petroleum Exporting Countries (OPEC), a cartel dedicated to supporting oil prices, the Saudis became concerned that the coronavirus pandemic was causing the oil price to decline. To stop or at least slow that decline, Riyadh worked to get oil-producing countries to agree to counteract falling prices with a production cut of 1.5 million barrels per day.
The Saudis were successful with OPEC and non-OPEC members, with one exception: Russia. On March 7th, it was clear that the Russians would not agree to any cut in their production, despite an existing 3-year old deal with Saudi Arabia. Riyadh then punished the Russians by undercutting prices to all their main customers – like Communist China – by increasing production by 2 million barrels per day.
On 20 March, Brent crude closed at $26.98 per barrel, far below Russia's cost of production. Even at $40, Russia loses $100 million to $150 million per day. Goldman Sachs predicts the price will continue to drop to $20 per barrel, far below Russia's budget needs. Analysts say that even if the ruble stays stable, Russia needs $40 per barrel, even with spending cuts and drawing on monetary reserves. With Russia's main exports being energy and weapons, there are few other options.
Two things drove Russia to make its drastic decision. First, Russia's power in the world, especially in the EU, has a great deal to do with energy politics. Russia is one of Europe's main energy suppliers, and with Brexit, that dominance will increase. The Nord Stream 2 gas pipeline is a critical element in Russia's European energy strategy and Washington, understanding that levied sanctions on the pipeline as well as on state-owned Rosneft. As a result, Moscow rightly believes that American fracking-based energy independence underpins Washington's ability to threaten Russia's global energy politics. That was demonstrated in the first days of March when Putin met with Russian oil companies. At that meeting, Rosneft's head, Igor Sechin, said that low energy prices "are great because they will damage U.S. shale."
Second, the Kremlin is determined to maintain the political influence it has achieved in the Middle East after years of expensive effort. To continue to meet those expenses, Russia must not only use profits from weapons sales but also from unrestricted production and sale of crude oil and gas. Propping up oil prices by restricting production does not fit that requirement, and higher prices certainly do not "damage U.S. shale."
As it continues to confront Russia's motives, Washington should take comfort in the knowledge that the dark clouds of the oil price war have silver linings with regard to American national security.
First, rock bottom oil prices that force Russia to sell crude at a net loss will undoubtedly impact its budget, which in turn will substantially lessen its appetite for foreign military adventures. As a bonus, low oil prices will similarly impact Iran. Together, those two aggressive nations continue to menace the United States and kill American soldiers on a roll call of battlefields.
In Iraq, Tehran is attempting to ramp up attacks by its proxy forces on bases manned by U.S. forces. These relatively minor and uncoordinated attacks are hampered by a lack of leadership and lack of essential funding. The recent U.S. killing of an enemy combatant, General Soleimani, has been as telling to Iran as the fall of oil sales revenue.
In Syria, Russia and Iran are successfully propping up dictator Bashar al-Assad at considerable cost. The Saudis are as concerned about Syria as they are about their long border with Iraq, so Riyadh will not be anxious to end the economic punishment they are meting out to Moscow and Tehran.
Who will win the oil war?
Russia has boasted they will survive selling oil at a loss for years by "adjusting the budget." Those adjustments will mean at least pausing their expensive aggression in Iraq, Syria, Afghanistan, and Libya, not to mention developing and brandishing new weapons aimed at NATO and the United States. Despite their brave front, the pain was already evident when Russia signaled it was willing to join an OPEC conference call to discuss market conditions. Saudi Arabia and other members did not agree to attend. The call was canceled.
Iran is using its disastrous domestic coronavirus epidemic as a ploy to gain sympathy, pleading for the lifting of sanctions. The firm U.S. response was to increase sanctions, excepting only agricultural and humanitarian supplies. With just a sliver of oil sales income remaining, domestic unrest, inflation and disease are turning the Islamic Republic into a failing state.
Saudi Arabia, like Russia, stated its budget can weather the lower oil prices for years and is already trimming expenditures by 5%. If further cuts are needed, it will be relatively easy for the Kingdom to postpone ambitious domestic projects – knowing they will not run out of oil for a very long time.
The United States, preoccupied with the coronavirus, is almost a bystander in the oil price war. Despite loud complaints from Wall Street brokers and the discomfort of over-extended oil companies, our domestic energy supply remains secure for civilians and warfighters. Gas prices at the pump have dropped to levels not seen in twenty years. We are filling our strategic reserve with inexpensive oil as a hedge against the future. And Saudi Arabia is an ally that has clearly stated, whatever else may drive it, that it has no intention of crushing our fracking industry.
As for Russia and Iran, Ronald Reagan once summed it up nicely: "They lose, we win."