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Saudi Arabia is launching an oil price war. That’s risky.

Without oil revenues, the monarchy could be in trouble

- March 22, 2020

Saudi Arabia picked a particularly inauspicious time to launch its latest oil price war.

As coronavirus travel restrictions cut massively into oil demand — and as OPEC and Russia failed to agree on extending long-standing oil production cuts — Riyadh declared on March 6 it would tear up the entire bargain. Instead of cutting production, Saudi Arabia would reverse course and raise output by 2 million barrels per day.

If that weren’t enough, the Saudis claimed they would increase overall production capacity to the unheard of level of 13 million barrels per day. Already weak oil prices promptly fell by more than half. Oil reached an 18-year low just over $20 on March 18 after five years mostly above $50, and nearly a decade around $100.

The yin-yang Saudi oil strategy made observers wonder whether this price war creates a big risk for Saudi Arabia and the other Gulf petro-states. Here’s why.

How much will Saudi Arabia’s oil price slash hurt its neighbors?

A “price war” is a blunt tool, and the principal weapon that Saudi Arabia has at its disposal to reestablish discipline among the world’s oil producers. Ramping up oil production pushes down prices, hurting rivals like Russia and America’s shale oil producers. It also sends a reminder that Riyadh’s status as the world’s lowest-cost producer means all rival producers depend to some extent on Saudi good graces for their share of the market.

Could this plan backfire, harming all oil producers? The world endured a short price war in 2014, and a devastating one in 1986 that hollowed out every oil town from Baku to Bakersfield.

The 2020 price war comes in the middle of a global economic crisis triggered by the coronavirus pandemic. The pandemic has already shaved down oil demand by a tenth, about 10 million barrels a day. As the virus spreads, oil consumption will probably fall further. Launching a price war in these circumstances looks irresponsible, at best.

Oil revenues ensure regime survival

The autocratic regimes of the Gulf stay in power by distributing oil profits to buy the support of their people. When oil profits dive, so does government spending, including the welfare benefits that compensate for the lack of political participation. Governments in OPEC members Indonesia and Venezuela were toppled by uprisings that followed oil shocks.

This is the biggest oil price crash in decades. That may not be great for the U.S. economy.

Autocrats in the past sometimes responded to discontent by allowing small increases in democratic participation. But in the aftermath of the 2011 Arab Spring uprisings, Gulf regimes feel too threatened to open up the political realm.

That leaves repression. Across the Gulf, repression has increased since the pan-Arab uprisings and the spread of ISIS. Saudi Arabia’s “political terror” score jumped from level 3 in 2011 to level 4 in 2018 —- a score of 1 represents secure rule of law; a score of 5 indicates unlimited government repression. Likewise, the UAE rose from a relatively free 1.5 in 2011 to a much more repressive 3 in 2018. Among the Arab oil monarchies, only Kuwait has remained steady, while Qatar saw a four-year increase in repression that has since been relaxed.

The latest dearth of oil revenues may trigger popular discontent — which, in turn, could exacerbate these repressive tendencies. The big risk, of course, is that repression — or deprivation — could set off large-scale protests.

The Saudi decision to cut prices and ramp up production came alongside arrests of rivals to Crown Prince Mohammed bin Salman within the Saudi royal family and the military. While the Saudi government has said the arrests were based on allegations of corruption, they might also have been a preparatory step for the oil price war that promises to severely hamper the government’s ability to spend. Arrests might serve as a warning to anti-regime plotters, rival royal factions or disgruntled members of the Saudi public that dissent will not be tolerated — and, perhaps, to pave the path for Mohammed bin Salman to succeed his father as king.

Why pursue a price war now, of all times?

Saudi Arabia is responding to both long-term trends in oil markets and more recent disagreements within OPEC. In early March, the Saudis initially proposed cuts that would have brought world oil production into line with estimates from the International Energy Agency, which forecast a roughly 3 percent drop in oil demand for the entire calendar year due to the coronavirus.

But Russia, apparently alone among OPEC+ members, refused to go along with Saudi Arabia’s additional production cuts. Russian oil policymakers, influenced by Rosneft chief Igor Sechin, argued that further cuts would only prolong the opportunism of U.S. shale producers, who had been free-riding on OPEC+ production cuts since 2016.

Each time OPEC cuts managed to boost oil prices, U.S. shale producers brought more oil to market. Sechin argued the Americans, already faltering under $50 oil, should be forced to make the necessary coronavirus cuts. (That possibility is now under consideration in Texas.)

With Russia unwilling to cut, Riyadh quickly shifted gears. Saudi Arabia has always maintained it would not bear the burden of balancing the market on its own. That meant the price war was on. Rather than protect revenue, Saudi Arabia would try to leverage low prices to recoup the oil market share it had surrendered to U.S. shale and others.

U.S. sanctions against Iran got tougher. What happens now?

What happens now?

The world has never experienced this type of simultaneous supply and demand shock, so there is considerable uncertainty. One likely early victim is Saudi Vision 2030, which aims to shift the Saudi economy away from oil dependence. Such diversification requires big oil profits to bankroll the incubation of non-oil businesses — and those profits won’t be available if the price war drags on for long.

If oil prices stay low, climate action will also suffer. Cheap oil is as disruptive to energy efficiency and substitute fuels as it is to politics. Fewer people are willing to pay extra for clean technologies when gasoline is cheap.

A key irony is that Iran may be the only big Gulf exporter that is insulated from the price war, since its exports have been shut off by the U.S. embargo. But Iran will also find it nearly impossible to retaliate in its usual way — attacking oil shipments and infrastructure — because doing so will have little effect on prices in a world awash in cheap oil.

The war could be short-lived. Saudi Arabia may climb down, now that it has successfully demonstrated its willingness and ability to shock the market. But the shock will already have made its mark on the global economy and on regional politics.

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Jim Krane is the Wallace S. Wilson Fellow for Energy Studies at Rice University’s Baker Institute in Houston. His recent book is Energy Kingdoms: Oil and Political Survival in the Persian Gulf (Columbia University Press, 2019).