Marriage is a non-binding contract. Each party is free to walk away from it. Its dissolution, however, always has consequences. Russia’s decision to divorce Saudi Arabia last Friday sent shock waves through the oil market. Prices fell 32% over the weekend, and global stock markets plunged on Monday. The OPEC divorce means that no one is managing global supply and demand balances.
I explained some reasons why Russia initiated the OPEC divorce to TRT World on Monday. I expand on these below, but also discuss Saudi Arabia’s decision on Sunday to flood the market and where U.S. shale will go from here. Russia’s decision is less about geopolitics than it is about market share. As I also noted in a tweet on Monday, Russia has thrived from 2012-2018—losing market share slightly but increasing exports by 1.7 million barrels per day. Saudi Arabia lost considerable market share and exports have plateaued, as it tried to balance the market. The United States has, of course, experienced a bonanza:
From 2012-2018, according to BP:
🇷🇺 Russian exports rose 1.7 million barrels per day (mbpd); market share dropped 13.1% to 12.8% 🙂
🇸🇦Saudi exports rose .085 mbpd; market share dropped 14.9% to 12.0% 😭
🇺🇸US exports rose 4.5 mbpd; market share rose 4.7% to 10.0% 🤑#oilmarket
— John V. Bowlus, PhD (@johnvbowlus) March 9, 2020
We don’t have official numbers for 2019, but it’s expected they would have continued these trends. Who knows after 2020?
The OPEC divorce will initiate a full-scale battle for market share among the world’s three largest producers in the coming years. The COVID-19-induced global recession alongside the energy transition will only intensify the quest for oil-supply security. Ultimately, I believe we will look back on the 2016-2020 Russia-OPEC cooperation as a blip. After some near-term intense economic and epidemiological volatility, the geopolitics of oil could revert to familiar form: a robust, bilateral U.S.-Saudi oil alliance.
Russia: all politics is local
Many believe Russia’s decision aimed to destroy U.S. shale production. I disagree, as I told TRT World. Its motives are sui generis. First, “it wants to keep its own producers happy – remember, Russia’s oil industry consists of private companies, who do not like being part of OPEC, even if the cuts were never huge.” Russian companies bowed to Kremlin pressure since 2016, but both Putin and the companies now want freedom.
A vital point, too, and often lost by analysts, is that the OPEC agreement itself was largely a mirage: “Russia only fully met its agreed cut levels during three months in 2019, when the Druzhba oil-export pipeline was contaminated.” With Saudi Arabia doing the heavy lifting for rebalancing the market, why would the Kremlin walk away from its free ride?
Russia believes, I think, that “it can keep its global market share, which has held steady this decade, and perhaps even win market share given its greater geopolitical reach.” Its relationship with China, built since 2014, will pay off. It can easily increase exports from its newer fields in eastern Siberia to China. Decoupled from OPEC, Russia is now free to wield geopolitical power to cut new, bilateral oil deals with specific countries to lock in market share.
The Soviet Union never joined OPEC. Russia signaled interest in 1998-99, 2001, and 2008-09, but never followed through. As a great power, Russia can achieve plenty on its own, especially amidst geo-economic volatility. Meanwhile, the energy transition is accelerating. Russia has new projects in the Arctic and eastern Siberia in the pipeline. Now is the time to produce and export as much as possible, especially with its financial situation stronger than in 2014. Russian oil is no good in the ground.
Saudi Arabia: it’s MBS’ country now
Saudi Arabia was shocked and dismayed by Russia’s decision to divorce. But it had to see it coming. COVID-19 is a massive blow to oil producers. It weakens Saudi Arabia more than any country given its whole-scale dependence on oil exports.
Much as during the period from 1982-86, Saudi Arabia has done the heavy lifting for OPEC since 2016 by propping up price to the benefit of Iran and non-OPEC producers, U.S. shale most notably. After the OPEC divorce, Saudi Arabia was in no mood to take this route again. Its decision on Sunday to flood the market means it too is charting an independent path. It also marks a return to its 2014-16 strategy, in which it sought to protect market share at the expense of price.
It was also not a coincidence that Mohammad bin Salman (MBS) further consolidated power after the OPEC divorce. MBS has sidelined the traditional technocrats overseeing the state and its existential oil strategy. He will need all the internal power he can to weather the difficult times ahead. Low prices will strain the Saudi economy and society. When Saudi Arabia flooded the market in 1986, prices remained low for the next 15 years. Who knows when the next rebound will come?
United States: energy dominance at risk
Unlike Saudi Arabia and, to a lesser extent Russia, oil prices do not drive the U.S. economy. A 2016 Brookings paper showed that the 2014 price decline did not stimulate growth. The price swoon did, however, hurt the U.S. shale industry, causing many bankruptcies of smaller players. This resulted in consolidation by larger players, who are amply capitalized to withstand a price decline. There’s no question that the OPEC divorce will weaken the industry again this time around, even if it is more resilient than in 2014. The OPEC+ cuts helped it grow spectacularly from 2016-19, much as the high prices during the so-called Arab Spring from 2011-14 enabled its initial growth.
COVID-19 adds even more uncertainty. The virus is inducing a global recession, and U.S. markets are terrified. Easy access to capital is one of the U.S. shale industry’s greatest advantages. If it loses it, the industry will shrink. U.S. shale pushed Russia and Saudi Arabia together in 2016. Its continued growth pushed them towards divorce in 2020. COVID-19 was the precipitating factor in formalizing a decision Russia had already made: to go on its own. It would be ironic, then, if the OPEC divorce thwarts Trump’s quest for energy dominance.
In foreign policy, the United States will, like Russia, seek revised bilateral oil-export agreements with its allies. It has used geopolitics to take Iran and Venezuela off the market since 2012, which has benefitted Russia, incidentally, as well. Other countries could be next. The gradual U.S. withdrawal from the Middle East last decade allowed Russia to return to the region in force. But this also made the United States more flexible to pursue specific core interests. As Russia breaks free from OPEC, the United States and Saudi Arabia, never far apart, will coordinate more. At the same time, the United States and Russia may deepen cooperation to restrict oil exports from the Middle East more broadly.
Photo credit: Kremlin.