In contrast with Russia, always reluctant to cut production because its declining yet still large population needs oil dollars to protect its living standards, KSA, which has a rising but still comparatively small population and owns very large external assets, can afford cutting production to beef up prices. This was the strategy followed by then oil minister Yamani in the early eighties, when rising non-OPEC producers threatened to cut market prices. Doing so, KSA was losing market shares year after year, until King Fahd fired Sheikh Yamani and made a U-turn, increasing output from 5 to 10 mb/d, making crude price collapse. Although that was not his purpose, King Fahd helped Paul Volker, then Fed chairman, to win the war against inflation, and kicked started the global economy. According to some analysts, the fall of oil price created the conditions for the collapse of the Soviet Union, suddenly starved of petrodollars.
Are we witnessing a remake of 1986? The common point is the fight for market share between two big producers, then OPEC vs. NOPEC, now KSA vs. Russia. Yet, the world is very different from what it was back then. First, US shale oil producers have become the dominant swing producer, making the game more complex. Second, because inflation has vanished, central banks are at, or close to the bottom of the feasible range of policy rates. Therefore, the collapse in energy prices, which will cut consumer prices, will not be fully compensated by lower policy rates, which, in turn, will increase real interest rates at the expense of the real economy. In other words, lower energy prices are not necessarily good news for the global economy. Besides, the market reaction to the new oil war was quite negative: because shale oil producers are highly indebted, the high yield segment of the bond market suffered heavy losses, reinforcing the downward pressure on equities. This shows how important is the oil war.
Russia, Saudi Arabia, shale producers, who’s going to blink first?
Russia has sound public finances, being one of the rare countries to run a budget surplus (1.5% of GDP in 2019), its government is almost not indebted (15% of GDP) and has built a hefty stabilisation fund for rainy days thanks to oil royalties. Yet, both the economy at large and public finances are highly dependent on oil income. Excluding energy, the current account and the government balance are in deep deficit, -8.6% of GDP in 2018 for the former and -6.2% for the latter. A 30% oil price drop would impact government balances and, more importantly, reduce households’ income, a politically sensitive topic.
Saudi Arabia is in a more precarious situation, at first sight. The government has a large budget deficit –more than 6% of GDP in 2019— dug by the rising social needs of the country, and its economy is even more dependent on oil than is Russia. Yet, KSA has accumulated colossal external assets –its international investment position stands among the highest in the world ($685bn or 92% of GDP in 2018) which provides the kingdom with a significant room for tactical maneuver. To restore KSA market power, Saudi Aramco has just been asked by MBS to prop production up to 13mb/d, still lower than US output (15mb/d) but significantly higher than Russia’s (10.8mb/d).
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