In early March, Saudi Arabia shocked oil markets by raising output in the face of collapsing oil demand, sending oil prices below the key $30 mark.
A month later, on April 12, Saudi Arabia, together with OPEC and its allies, agreed to cut oil production by 9.7 million barrels per day for the next two months.
This agreement came a little too late, however. Oil prices continued to plunge, with Futures contracts for May delivery trading at -$37 as holders were paying to avoid taking physical delivery of the product in a world running out of storage space for the commodity.
Popular exchange-traded funds like the United States Oil Fund (USO, Financial) suffered hefty losses, too.
What's the Kingdom's game this time around, and why did Saudi Arabia increase output in the first place? Oil market experts have a number of explanations for the country's actions.
In an Op-Ed piece published on March 7 by Bloomberg, Ilya Arkhipov, Will Kennedy, Olga Tanas andGrant Smith argue that the Saudis and the Russians have separately declared a second price war against American frackers.
But Jay Park, CEO of ReconAfrica, doesn't subscribe to this theory. "If this were the Saudi's and Russians trying to kill off the shale business in the U.S., they would have agreed to do that… instead, the Saudi's went from proposing a multi-million-barrel quota cut on Friday, to bumping up production on Saturday," he said.
Park's theory is that Saudi Arabia's action this time around is a declaration of a price war against Russia. "This is Saudi vs. Russia," he says. "Saudi wants Russia back in the OPEC+ camp. We don't know the impact or duration of the virus, and price wars can last day, weeks, months, or even years."
Bernard Haykel, professor of Near Eastern Studies and director of the Institute for the Transregional Study of the Contemporary Middle East, North Africa and Central Asia at Princeton University, has another theory.
"Although Saudi Arabia's recent decision to hike oil production coincided with the broader Covid-19 crisis, it reflects a broader and more fundamental strategic shift led by Crown Prince Mohammed bin Salman," he wrote in “Saudi Arabia’s Radical New Oil Strategy,” which was published in project syndicate. "With a global clean-energy transition inevitable, MBS is desperate to cash out while the Kingdom still can."
A significant shift, indeed. For years, Saudi Arabia was the master of the oil market, managing its oil reserves for future generations. And it played this role in different ways. For example, sometimes it was a "swing" producer, stabilizing oil prices like back in the 1970s, when the country filled the gap created by the decline in U.S. oil output, the 1978 to 1980 gaps created by the Iranian uprising and the 1990-91 shortages created by the Iraq-Kuwait war.
Other times, Saudi Arabia played the game as a warrior. It used oil as a weapon against countries that disagreed with its policies. It used this strategy during the 1973-74 oil embargo, intending to punish countries that sided with Israel.
But Saudi Arabia can no longer be the master oil markets, managing its reserves for future generations. "Gone are the days when Saudi oil reserves were prudently managed for future generations," Haykel said. "By no longer maintaining a specific oil-price band or retaining spare production capacity, the Kingdom is stepping away from its longstanding role as the market's swing producer."
Why this significant policy shift? Why now? Because Saudi Arabia wants to stop renewable energy companies from competing with fossil fuels, according to Haykel.
"By keeping prices depressed, Saudi policy will not just drive more expensive forms of oil production out of the market; it will also make it harder for renewable energy to compete with fossil fuels – at least in the near term," he added.
But there's a third theory. Saudi Arabia desperately needs money to close the gap in its social budget that relies on oil revenues, much more than Russia. Saudi Arabia recorded a government budget deficit equal to 9.20% of the country's gross domestic product in 2018, as Russia recorded a government budget surplus equal to 1.80% of its GDP in the same year.
While it's still unclear who will win this round, one thing is clear: consumers will benefit from lower prices, provided, of course, that Covid-19 doesn't keep them detained in their own homes.
"Price wars don't help anyone but consumers, and even that is arguable, as prices are likely to whipsaw back later and logical behavior for exploration and development will be an early victim," Park said.
Disclosure: I don't own any shares of USO.
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