In the game of chicken, two drivers race toward one another head on. The one who swerves first to avoid a fatal crash is the chicken. Classic game theory.
So it is with Russia and Saudi Arabia, which last week ended their bromance and opened up their oil spigots. On Monday, oil prices fell by almost a third at one point, the biggest drop since the 1991 Gulf War, and ended the day down more than 20 per cent. On Tuesday, prices rose by about 6 per cent, to US$36 a barrel, but the loss since early January, when oil topped US$68, was still horrendous.
The outlook doesn’t look good. Saudi Arabia signalled on Tuesday that it will dump another 2.3 million barrels a day onto the global market, taking its total daily supply to an astonishing 12.3 million barrels. Olivier Jakob, a former oil trader who is managing director of Swiss oil consultancy Petromatrix, called the Saudi move highly aggressive: “forcing as much crude as possible in a market that does not want it.”
The oil war is on. Who will swerve first, the Russians or the Saudis?
The more popular view says the Saudis will win – their ability to tough it out over the long run exceeds that of the Russians. This belief centres on three factors.
The first is that, among the world’s largest producers, Saudi Arabia alone has the ability to raise production substantially, as it’s doing now. The implication? What it loses in price it can make up, or largely make up, in sheer volume. If prices fall, say, 15 per cent, but the number of barrels the Saudis sell rises by a similar amount, the country’s revenue stream remains more or less intact.
The second is that Saudi Arabia, with a bit more than US$500-billion in foreign-exchange reserves and the proven ability to raise debt in the bond market, is equipped with ample financial buffers. Its debt-to-GDP ratio of just 25 per cent gives it a lot of room to borrow.
The third is that Crown Prince Mohammad Bin Salman, the kingdom’s effective ruler, is running on ego and pride and won’t allow Russian President Vladimir Putin to humiliate him. The 34-year-old prince, known as MBS, blames Mr. Putin for blowing up the Russia-Saudi oil alliance, which sought to prop up prices through production cuts.
MBS now wants revenge. This is a grudge match and the best way to punish Mr. Putin is to knock the price down to the point where he sues for peace.
I am taking the opposite view: Russia will inflict more damage on Saudi Arabia than the other way around.
First, Russia has ample financial buffers, too. Whether it’s companies or countries, the strongest balance sheet usually wins. Russia’s international reserves are some US$80-billion greater than Saudi Arabia’s and its debt-to-GDP ratio, at a mere 15 per cent, gives it even more financial flexibility than Saudi Arabia.
Russia’s ability to balance its budget at low oil prices is substantially greater than Saudi Arabia’s. Chris Weafer, investment strategist and chief executive of Moscow’s Macro-Advisory, says Russia needs US$38 a barrel to clear its budget (others estimates are lower).
Saudi Arabia needs at least double that price. Remember, the 15,000 members of the extended royal Saudi family have expensive tastes. MBS owns a US$500-million yacht and is thought to have been the buyer of the US$450-million Leonard da Vinci painting, Salvator Mundi. You get the idea.
Mr. Putin and his buddy, Igor Sechin, the boss of Rosneft, Russia’s biggest oil company, are also forceful operators who don’t shy away from a good fight. But for them, the fight isn’t just with Saudi Arabia and its mighty Saudi Aramco oil company; it’s with the Americans, specifically with their shale oil and shale gas producers, which have propelled the United States into the energy super league in recent years.
The duo’s goal now is to use low prices to cut the market share of the weakest producers and drive them out of business. Their motivation is doubly reinforced by their desire to get even with U.S. President Donald Trump, who used sanctions to prevent the completion of the Nord Stream 2 pipeline that would deliver Siberian gas to Germany, and to damage Rosneft’s Venezuelan business.
Both Russia and Saudi Arabia are taking big gambles that will hurt both of them before a victor is declared. Neither is an easy foe, nor is the U.S. shale industry. In 2014, the Saudi-dominated Organization of Petroleum Producing Countries used a price war to try to snuff out the U.S. shale companies.
It didn’t quite work. The U.S. shale business recovered and is pumping more than ever. Venezuela, an OPEC member, collapsed. Can Russia win where the Saudis failed? Doubtful.
Still, Russia seems to have more financial staying power than Saudi Arabia in this grubby oil war and insists it can endure prices at US$30 a barrel or less for several years. Perhaps. But don’t rule out the possibility that neither side will swerve. A head-on crash should not be ruled out in this global game of chicken.
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Eric Reguly