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Why has Saudi Arabia launched an oil price war?

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·3 min read
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Oil barrels with hands and coins
Oil barrels with hands and coins

An international row between two of the world’s biggest oil producers – Saudi Arabia and Russia – has triggered a price war and sent the price of crude spinning to its fastest fall since 1991, just at the time when the coronavirus crisis threatens to torpedo the global economy. 

Brent crude, the UK benchmark, now stands at just $35 a barrel and is down almost 50pc this year. Equity markets has tumbled, with FTSE 100 having one of its worst days since the financial crisis. But what caused the row and what will its impact be? 

Why are the Saudis cutting prices?

Ironically the turmoil has come out of failed efforts to shore up the price by the Opec oil producing cartel – which counts for around 30pc of global production – and nine other non-members, led by Russia, which had together formed the Opec+ coalition.

Russia relies on oil and gas sales for around a third of GDP and was keen to wait until the impact of the virus became clearer. The Vienna talks broke up without agreement on Friday when the Russians snubbed a Saudi offer of cutting by 1.5m barrels a day. The Saudis stunned markets by slashing export prices 10pc over the weekend.

What else is driving Russia?

Vladimir Putin’s economy is under the cosh from US sanctions and wider geopolitics are in play, particularly after Donald Trump used sanctions to block the completion of the Nord Stream 2 pipeline between Siberian oil fields and Germany. 

The Opec+ coalition’s production curbs had never been widely popular in the Russian oil industry and there was also a willingness to squeeze the wider US shale industry – which has higher costs of production – with lower prices. 

What does it mean for Opec?

The Saudis were making up for the non-compliance of other Opec members in the previous production cut regime – such as Iraq and Nigeria – by undershooting their production quotas. Now all bets are off. Opec should grab market share because it has the lowest cost of production.

Other major producers such as Iran and Kuwait are likely to follow the Saudis with price cuts, but the pressure will tell on the public finances of the weaker Opec members. 

How low could the price go?

The oil price was already facing a tough year thanks to new non-Opec producers such as Brazil and Norway increasing supply. The Saudis have just massively magnified the supply glut while coronavirus kills off global demand. The virus has already had a deep effect on the market:

One oil expert, Citigroup’s head of commodities Ed Morse, says an oil price in the $20s is a realistic prospect. “This is the first time I can recall there has been a significant oversupply crunch and a demand shock at the same time,” he said.

How long will it last?

The Saudis are the biggest oil exporter in the world with the cheapest cost of production. The state-owned producer Aramco can get oil out of the group for less than $3 a barrel, which puts them in a stronger position to survive a price war. 

But a prolonged battle would put pressure on even the Saudis’ finances, which is why they are keen to diversify their economy under ruler Mohammed Bin Salman’s Vision 2030 programme. Ratings agency Fitch estimates the Saudis need a price of $82 a barrel to balance the books.

What does it mean for the UK?

The UK is a net oil importer, so firms across the country will have cheaper production costs. Motorists should also feel the benefit at the forecourt, although the majority of a litre of petrol is made up of fuel duties and VAT.

A low oil price should provide a modest tailwind for an economy likely to be ravaged by coronavirus in the next few months. The Bank of England could soon be writing a letter to the Chancellor explaining why inflation is more than 1 percentage point below its official 2pc target.

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