By Daniel McGroarty, TES GeoPolicy Editor
APRIL 14, 2020 UPDATE: In one of the few non-COVID news stories still commanding attention, global economy watchers are focused on an Easter agreement brokered by Saudi Arabia that aims at global oil production cuts of at least 10%. The catch: the cuts won’t come immediately, but in May. Spot markets didn’t worry about the long-dated production cut, as spot oil prices rallied. Predictably, over on the information market, there’s a glut of conventional opining that the 2020 Oil War is over.
Global energy strategist Peter Zeihan has a different take. He notes that Saudi is adjusting the nozzle on its oil weapon to direct fire to its east (at the Asian markets Russia prizes) and away from its west (America and its vulnerable fracking sector). The key isn’t barrels of cuts to come in May, but rather an immediate price hike that will give U.S. producers a $5 per barrel respite – and likely allay the ire of the American president, aware of the devastation in the U.S. fracking patch — a price break not extended to Saudi’s Asian buyers.
If Zeihan is right, expect the brief oil price recovery to flicker and fade, as more tankers set sail full of crude with no destination. Will Saudi maintain a two-tiered pricing system? Will either Riyadh or Moscow follow through with newly promised production cuts?
The oil wars aren’t over yet.
Just when we’re all loading our phones with Sick Map apps to track coronavirus as it burns across the planet, comes another crisis to worry about: An “oil war,” sparked by Russia and Saudi Arabia, contenders for world leading producer, until both were supplanted by the United States and its fracking boom.
It’s an open question why Vladimir Putin and Mohammad bin Salman (MbS) chose this moment of corona, which looks likely to plunge the world into recession, to play a game of chicken to see which side can pump more oil into world markets and make the other side blink first. Both countries were cooperating to keep production down, until they noticed that a smooth oil market was allowing U.S. frackers to take the world lead. Russia and Saudi asked each other to notch back production; neither would. And then without warning, both vowed to pump the other into submission. The spot price of oil promptly plunged 30%.
Who will win? Russia is in a different place today, having systematically banked up its sovereign wealth funds and lowered its budgetary breakeven oil price from over $100 per barrel during the 2008-09 global recession, to $40 today. Even if Russia’s claims of being able to endure an oil price war for 6 to 10 years are just bluster, all it may take to prevail is to have the wherewithal to outlast Saudi Arabia by a day.
And of course analysts are asking, what will the U.S. do?
Actually, for all the immediate uncertainty, that question can be answered. The U.S. – as in the U.S. Government – won’t be doing much of anything. Unlike Crown Prince Salman or Czar Vladimir, the U.S. President doesn’t “run” the U.S. economy, and certainly not a sector as fractious as the fracking wildcatters who have driven the recent American energy renaissance. Even this week’s decision to suspend scheduled sell-downs from the U.S. Strategic Petroleum Reserve proves the point: The suspended sale of 12 million barrels is equal to less than one day’s production from American rigs. World markets shrugged, and the oil price continued its plunge.
All of which is to say that, if this is war, it is wildly asymmetrical, as Pentagon planners would say: Two authoritarian nation-states start the conflict, but the U.S. response will be the aggregate of a hundred micro-actions by ten thousand independent American frackers – each with its own breakeven production price, debt load and credit lines, and many closer in size to mom-and-pop hardware stores than ExxonMobil. None of them have access to sovereign wealth funds or hotlines to Riyadh or Moscow, or OPEC in Vienna to see if there’s a cease-fire on the horizon.
To say the oil war is asymmetrical doesn’t mean the U.S. is destined to lose it. In the larger battle between authoritarian rule and the market model, markets have the upper hand, and earlier policy decisions have done much to advantage the U.S. – beginning with the Obama Administration’s ending of the 40-year oil export ban, and the Trump Administration’s deregulatory push that let a thousand fracking wells boom.
As for how the current oil war plays out, some of the U.S. response will be simple economics: If Moscow and Saudi continue to pump full out, American frackers will idle rigs and halt drilling. The impact will be near-term, as fracking wells have radically shorter production lives, requiring new wells to be brought online in near continuous fashion. Lower production will put a floor under falling oil prices, but at what price – and at what cost to American producers, and the American economy?
And how will all this play out in an American election year, compounded by the economic ravages of coronavirus? Three of the biggest U.S. fracking states – Pennsylvania, Ohio and New Mexico – are also political swing states. The fact that the U.S. Government’s levers are limited doesn’t mean some sort of intervention won’t be attempted – whether wise or unwarranted is TBD.
Then there’s the wild card: Iran. Russia and Saudi may be aiming at each other, and Putin may even intend to cripple U.S. oil dominance as payback for U.S. sanctions on Russia’s Gazprom, but Iran could be the country caught in the cross-fire. Crippled by sanctions, riddled with coronavirus, and presiding over a cash-guzzling secret nuclear weapons program and an economy in collapse, a protracted oil war could be the precursor to Iranian regime change, with unknown aftershocks across the Middle East and far beyond.
The timing for Teheran could hardly be worse. Russia may have fattened up its national treasury in order to wage oil war, but Iran can’t say the same. Iran’s budgetary breakeven oil price? A staggering $194 per barrel, according to the IMF. With the discounts Iran must offer to sell oil surreptitiously to circumvent sanctions, if oil breaks below $30 per barrel, or even bounces around in the $30s, Iran’s regime may not generate enough cash to keep its henchmen happy.
So while Putin and MbS continue their stare-off, the mullahs – at least those of them not carried off by COVID-19 – may find themselves on the wrong end of a people’s revolution.
But don’t expect the mullahs to go quietly. For now, the “oil war” is a metaphor. That could change to the real kind. Teheran could use what ZeroHedge calls “non-market tools” to change the facts on the ground: Crisis and chaos, as manufactured by Iran’s terror network and non-state bad actors, whether aimed at Saudi Arabia, Israel or even Russia’s Muslim regions. As history teaches, nothing boosts oil prices better than mayhem. And when economic levers aren’t working and the regime is wobbling, there’s not much left to lose. An Iran on the ropes could be the most dangerous factor in how this oil war plays out.
Putin and MbS have started this. How it ends, and what the world looks like when that happens, could mark an inflection point in 21st Century geopolitics.
Daniel McGroarty, TES GeoPolicy editor, served in senior positions in the White House and Department of Defense, and has testified in the U.S. Senate and House on critical minerals issues. McGroarty is principal of Washington, D.C.-based Carmot Strategic Group, and president of the American Resources Policy Network, a non-partisan virtual think tank dedicated to informing the public on the importance of developing U.S. metal and mineral resources. The views expressed here are his own.