Bottom Line Up Front:
The April agreement among major oil producers to reduce global oil production has failed to stabilize world oil prices.
Market stability will depend heavily on the abatement of the COVID-19 pandemic.
U.S. oil production is falling because of high costs and high debt loads in the face of plummeting demand.
Saudi Arabia is harmed significantly by an unstable oil market because of its lack of diversification and domestic demands for government largesse.
In early 2020, the global oil market has been in free fall from the COVID-19 pandemic as well as a clash between two major producers, Russia and Saudi Arabia. The oil price crash is the first such collapse since the United States has become a major oil producer, a development achieved on the strength of U.S. technology to extract oil from shale deposits through a process of ‘fracking,’ or hydraulic fracturing. The United States’ emergence as a major producer has muted traditional U.S. opposition to production cartels such as the Organization of Petroleum Exporting Countries (OPEC) that keep prices elevated. OPEC is dominated by Saudi Arabia, which is the largest and lowest-cost producer. Several close Persian Gulf allies – the United Arab Emirates and Kuwait – are OPEC members that reliably support Saudi oil market strategy. Over the past four years, Russia and OPEC have been aligned in an ‘OPEC+’ arrangement that had kept prices relatively stable at about $55 per barrel until the COVID-19 pandemic hit.
When OPEC negotiations with Russia for a production cut collapsed in early March, Saudi Arabia increased production and cut prices in an effort to restore its control over the global market. President Trump decided to intervene to rebuild a Saudi-Russian consensus in an effort to help beleaguered U.S. shale producers, who require a price of at least $40 per barrel to be viable and who have accrued billions of dollars in debt over the past decade. The threat to the domestic U.S. oil industry created a significant problem for President Trump, insofar as the COVID-19 pandemic was already driving the United States into a major recession. A wide-scale debt default by shale producers would further weaken an already vulnerable U.S. financial system.
On April 12, direct intervention by President Trump with Saudi de-facto leader Crown Prince Mohammad bin Salman (MbS), Russian President Vladimir Putin, and other OPEC and non-OPEC country leaders produced an agreement for a collective cut of 9.7 million barrels per day of crude oil production. However, the production cut has not been nearly enough to compensate for the COVID-driven drop in demand, and oil prices have continued to fall. Excess production is beginning to outstrip the supply of oil storage facilities. Some U.S. shale oil producers have already filed for bankruptcy, and other failures are likely as lenders deny them additional credit. President Trump cannot mandate that U.S. companies cut production, but the state of the oil market will ensure that U.S. production falls, contributing to a restoration of market equilibrium. Yet, the reduction in global oil demand caused by COVID-19 lockdowns is so great (estimated at 25 million barrels per day) that a significant price recovery will depend on a resolution of the pandemic and a return to global economic growth.
For Saudi Arabia, the oil market collapse could have dire consequences. Saudi Arabia requires a price of $80 per barrel just to balance its budget. A price one quarter of that level will require the Kingdom to issue debt as well as draw down further on its sovereign wealth fund balances. MbS will be almost certainly unable to realize his ‘Vision 2030’ program, announced exactly four years ago, that is intended to diversify the Saudi economy and satisfy expectations of guaranteed jobs and a high standard of living. The Kingdom’s political system is not in imminent danger, despite MbS’ many missteps, which also include the disastrous war in Yemen. The privatization of Aramco in 2019 extended the Kingdom’s financial lifeline for at least several years. Yet, the Saudi contribution to the 2020 oil price collapse has added fuel to the already burgeoning criticism of MbS and the Kingdom among key U.S. policy circles. Moreover, with a decline in Saudi Arabia’s domestic economy, it may not be possible for MBS to fulfill his promises to modernize the Kingdom. Economic distress combined with mounting pressure from demographic trends could signal trouble for MBS and his reckless approach to domestic and foreign policy. His quest to implement reforms may soon become unpalatable as growing instability clouds Saudi Arabia’s uncertain future.