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Only a few days ago, Saudi Arabia was pushing for a production cut among its oil-producing allies, including Russia. On Sunday, the kingdom did exactly the opposite and opened the spigots, sending prices down more than 30 per cent, the greatest loss since the start of the 1991 Gulf War. The sudden reversal shocked the energy, equity and bond markets around the world.

Saudi Arabia has in effect declared war on oil powerhouses Russia and the United States. Why the sudden reversal?

The U-turn hammered oil, which was already losing value at a rapid rate as COVID-19, the disease caused by the novel coronavirus, swept across the planet. In early European trading, the price of Brent crude, the international benchmark, fell below US$32 a barrel before recovering somewhat to just under US$35, down more than 23 per cent on the day. In early January, Brent was trading north of US$65.

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American natural gas prices fell to a 21-year low and shares of Riyadh-listed Saudi Aramco, the world’s biggest publicly traded company, fell well below its initial offering price. Aramco has lost about US$500-billion in value since December, putting its plans for an international listing in jeopardy.

Saudi Arabia is the effective leader of the Organization of Petroleum Exporting Countries (OPEC). Since 2016, its main non-OPEC ally has been Russia, forming what’s known as the OPEC+ group. The Saudis and the Russians have always had an uneasy alliance, but they worked together to curb production to try to prop up prices. The pact more or less worked. Since early 2018 until January, oil prices generally ranged from US$60 to US$80 a barrel, more than enough to clear Russia’s budget and almost enough to clear Saudi’s.

Recently, the OPEC+ deal strained relations between Moscow and Riyadh. According to Bloomberg and other media reports, Russia wasn’t happy that the propped-up oil price was effectively subsidizing the burgeoning U.S. shale industry – the U.S., not Saudi Arabia, is now the world’s biggest oil producer.

Russian President Vladimir Putin was also angry that Donald Trump was using energy as a political weapon against the Russians. The U.S. President had used sanctions to prevent the completion of the Nord Stream 2 pipeline from Siberia’s gas fields to Germany (upsetting German Chancellor Angela Merkel). Mr. Trump went after the Venezuelan business of Rosneft, the state-owned Russian oil giant, too.

On Friday, the OPEC+ group met in Vienna and oil traders assumed that COVID-19’s trashing of oil demand and prices since January would all but ensure a production cut – the Saudis were making the case for an output reduction of about 1.5 million barrels a day on top of the reduction of 2.1 million barrels that had already been agreed. But Russia refused and the meeting broke up with no agreement of any sort. At that point, Saudi Arabia went to war by offering steep discounts to its customers around the world.

The brawl has the Saudis punishing the Russians and the Russians punishing the Americans. Of course, the oil industries of all three countries will suffer tremendously. Oil wars typically produce no winners. Remember, in 2014, Russia and the Saudis teamed up to try to shut down the U.S. shale industry. The production free-for-all sent prices spiralling down to about US$30 a barrel from US$100, yet shale oil managed to survive.

Where oil prices go from here is an open question, but there is a good chance they will not recover quickly. On Monday, the International Energy Agency cut its forecast for 2020 oil demand growth to negative 90,000 barrels a day. Only last month, before COVID-19 began to hit Europe hard, it was forecasting a rise 820,000 barrels a day. If the new IEA numbers prove accurate, global oil demand will contract for the first time since 2009, when much of the world was mired in post-financial crisis recession.

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Cheap oil will produce some winners. The price of a fill-up will fall, putting more coins in consumers’ pockets. Home heating bills should fall, too. Sales of gas-guzzling SUVs might pick up.

But there will be a lot of losers, too. Oil and gas shares were slumping even before Russia and Saudi Arabia went to war and now face near free-fall. Some of the highly leveraged shale companies won’t make it. With oil so cheap, the green energy revolution might be put on hold. Saudi Arabia might face a financial crisis, since it needs oil prices of US$80 or more to balance its budget. (Russia needs US$38, according to analysts, so might have more staying power). The high-cost Alberta oil sands companies, already hurting from the recent price slump, will experience more pain.

The COVID-19 outbreak could trigger a global recession. Were that to happen, oil prices could fall further. Energy investors are in for rough ride.

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