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Russia-Saudi Price War Pressuring Oil? That's The Wrong Narrative

Published 03/12/2020, 11:35 AM
Updated 09/02/2020, 02:05 AM

The oil market has been exceptionally dramatic and eventful over the last week. A combination of fundamentals along with misinformation has led to heightened volatility and a collapse in oil prices.

But the current market narrative is deceptive. Below, are the real, crucial issues for traders. Here's what transpired and what's actually driving market instability right now:

What Really Happened:

For most of last year, the market has been obsessed with the prospect of a global economic slowdown and fear of diminishing demand growth. The emergence of coronavirus only exacerbated these concerns further and introduced the prospect of a decline in oil demand in 2020.

It was reported that China—ground zero for the pandemic and thus far hardest hit by the coronavirus—reduced the cargoes of oil it would buy from West African oil suppliers and from Saudi Arabia. The prospect of lower demand, especially from China, stoked market worries and oil prices started to drop.

WTI Weekly Chart

At its meeting last week, OPEC reacted by floating a production cut, designed to decrease supply enough to counteract lower demand and stabilize the market. Russian support for a production cut was necessary since OPEC was working with non-OPEC members within the OPEC+ framework.

Because Russia, China’s second-largest oil supplier, hadn't seen a reduction in its sales to China, the European nation didn't believe there was a reason to cut its own production to satisfy OPEC’s desires. When presented with a plan on Friday, Russia, acted in its own self-interest by vetoing the cut, seemingly splitting OPEC+ in the process.

Over the weekend, news emerged that Saudi Arabia was both offering oil at significantly discounted prices to customers—primarily in Asia—and increasing its available supply to 12.3 million barrels per day. These actions enerved the market, making it appear as though Saudi Arabia was starting a price war with Russia.

In reality, a price war means attacks come from both directions: the next salvo would have to come from Russia, then Saudi Arabia, then Russia, etc. That hasn't happened yet. The market was so anxious about a potential price war, that when international exchanges opened at the start of the week, oil prices dropped over 30%.

Russia responded to the Saudi move by saying it would increase its production (not necessarily decrease prices) and that it, if necessary, was ready to use its $150 sovereign wealth fund to support the economy and cover budget losses. On Tuesday, Saudi Arabia announced it was prepared to supply up to 12 million bpd.

This was a big deal. That number meant Saudi Arabia would be using up its spare capacity.

However, on Wednesday the Kingdom clarified that it would increase its government-mandated capacity to 13 million bpd, immediately setting off alarm bells since there was a misunderstanding about what Saudi Arabia meant by increasing its capacity. The market seemed to believe that this indicated additional production.

While that wasn't the case, for traders, what the market thinks is key. And right now, the market is scared of a price war.

Narrative Fueling Market Instability

So far, events do not confirm that Saudi Arabia and Russia are in a price war, but we will eventually see if Russia is going to lower its prices below Saudi Arabia’s.

What we have now are two out of the three biggest producers in the world flooding the market with cheap oil. They are very likely looking to raise global demand numbers in hopes prices will stabilize.

Meanwhile, the market seems convinced that we have a price war, and that is why it’s so skittish. The instability and the threat of big drops will continue as long as this narrative persists. An actual price war could last months or years, but if Saudi Arabia and Russia instead succeed at shocking oil demand back to life, we could see stabilization at least when demand numbers come out in early May.

Latest comments

lets have fingers crossed, we are out of the stagnation early than we think, and the market can rol again
As always thoughtful analysis.
It is true that most market analysts don’t have a clear picture of market fundamentals and price behavior. You explained very well. However what satisfy analysts and market watchers is that Saudi Arabia and Russia disagreed over production cuts and entered a market share war. Mr. Zaki Yamani once called it Fair Market Share Policy. The difference this time is that the Kingdom virtually started pumping more oil though from storages plus offering lavish discounts that wasn’t demanded by customers.
They are most certainly in a price war. Russia refused cuts so Saudi  cut prices and increased production and Russia said they would increase production. So just as you say we have a ******for tat and therefore a price war. The only thing not 100% clear is their motives. Is it directed at U.S producers? Is it chest bumping by these two players or is it all of the above. The bottom line is that it is crushing U.S producers. The Feds need to step in and use whatever leverage they have to get this under control/
Nice article but beg to disagree. demand will continue to drop massively and production, unless halted, will flood markets and replenish floating storages. Producers will need to offer enormous discounts to place their product but market is not absorbing most of the oil. Nigeria only was able to place half of it's production. Oil war is here and nothing can be done. Russians were right. Cutting was only a make up to the market.Three years of cuts and market manipulators won nothing but to strengthen US Shale.my two cents from the field
I am sending you an invoice for wasting my 10minutes
What is is the "European nation"? :-D
Dr. Wald is referring to Russia.
great thoughts but yes you didn't speak to Russian and Saudi desires to ********the shale producers
You get your phd from university of phoenix? Dunbest thing ive reas
This is a coordinated effort to bring down US shale...everyone seems to have forgotten about the high-five at the most recent G20 Summit.
We have needed this for years. If OPEC had some backbone back in 2016 they would have put some floor in Shale then. They just kicked the pain can down the road and here we are. It will take a year for Shale to bring in production. It needs to drop at least 3mbpd back to 10 in order to bring things under control.
the russian bear should bows to our demands 🇸🇦
already bowed
Whoever laughs last laughs a lot
europe will have the last laugh as we move faster away from oil LOL
usa should also declare cut in production .as opec and Russian cut usa took advantage
The Opec deal was destined to fail. The price was going down anyway.
Russia and Saudi cut USA floods the market so itvis USA that needs to cut
US oil production last week was cut by over 65,000 barrels, demand is shrinking faster than production can be slowed. No company wants to drive down prices below the cost of production.
"What we now have are two of the three biggest producers in the world flooding the market with cheap oil." At approximately 13 mbpd, it's 3 of 3 flooding the market, for the time being.
So ur saying US and Russia have increased supply? It seems more like only Saudis did that, the rest is shrinking demand. In fact, Fracking has slowed as those producers lose money on every barrel at this point.
Thanks for the insight
Lol you’re the wrong narrative. I just read that there is a price war.
This article does not reflect reality. When saudi says they are going to increase the production to 13mbpd it is to sell those to offset any drop in price that they are already expecting. They already know it is going to hurt their bottom line even with the increased sales. But it wont be any worse than if they did not and saw a drop in price anyway.  The simple calculation is to make Russia feel the hurt of their non-co-operation, with inflicting the budget shortfall hurt on Russia. They know either way they will have to take a hit on their own budget for the next 4 months. At least in the next negotiation Russia will think twice before playing the russian roulette.          Oil will drop and continue to drop,  The only thing that will stop the oil slide is  if Russia finds a way to cut production now accepting Saudi compromise.  There will be no winners among russia and saudi. Shale will survive because they are hedged for the next 4 months until the Virus scare ends.
A spoken war seldom becomes a real one. Wise people know when to calm down and show no more the teeth.
Good note , but looks very optimisitc. The sequence of events actually do not point what you have written, may be yes its not a price war but we can say its a ego war
how can you chock out demand, during pandemic increasing lockdowns?
thank you Ellen
Very good summary.
Very well explained indeed!!!🌹
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