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Tue 10 Mar 2020 03:11 PM

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Saudi Arabia strikes opening blows in oil war, but can it go the distance?

Saudi Arabia says it has an output capacity of 12 million bpd but it is not known for how long it can sustain such levels

Saudi Arabia strikes opening blows in oil war, but can it go the distance?

In December, the kingdom announced spending of 1.02 trillion riyals as part of its budget for 2020 as it continues to develop non-oil sectors of the economy – tourism, entertainment, manufacturing and construction – in line with ambitious plans to overhaul the oil-dependent economy.

Saudi Arabia may be up for a fight over oil prices with Russia, but doubts have been cast if the kingdom can last the pace without causing long-term damage to its own economic ambitions.

Gulf stock markets have been sent tumbling in the past two days, dropping to multi-year lows after oil producers failed to reach an agreement on output cuts in an impasse that sent oil prices crashing.

After Russia rejected calls from oil-exporting cartel OPEC, which includes Saudi Arabia, for deeper output cuts to combat a coronavirus-fuelled slump in demand, Riyadh responded by driving through massive price cuts in a bid to win market share.

Saudi Aramco plans huge oil output hike to escalate Russian price war

Saudi energy giant says it will boost its crude output to 12.3 million barrels per day in April

The onset of coronavirus had caused Q1 2020 oil demand to be 4 million b/d (four percent of demand) below Q1 2019. While the ‘Russian factor’ resulted in at least an extra 2.1 million b/d (two percent) of oil on the market.

Even before the deadly virus struck, the market was already over-supplied, add the six percent change and that is why price dropped to $36/bbl, from $65/bbl at the start of 2020, on Monday.

Spencer Welch, director of oil markets and downstream at IHS Markit, admitted the development will be “hugely damaging” for oil producers. “It is reported that Saudi Arabia already needs a price of around $70/bbl to balance its economic spending plans, while it is reported that Russia needs a price around $50/bbl, so both are suffering,” he told Arabian Business.

In December, the kingdom announced spending of 1.02 trillion riyals as part of its budget for 2020 as it continues to develop non-oil sectors of the economy – tourism, entertainment, manufacturing and construction – in line with ambitious plans to overhaul the oil-dependent economy.

The price war was escalated on Tuesday as energy giant Saudi Aramco announced plans to boost its supply of crude oil to 12.3 million barrels per day in April, effectively flooding the market.

The world's biggest crude exporter has been pumping some 9.8 million bpd which means it will be adding at least 2.5 million bpd from April.

Saudi Arabia says it has an output capacity of 12 million bpd but it is not known for how long it can sustain such levels.

William Jackson, chief emerging markets economist at Capital Economics, said: “The sharp fall in oil prices will push current account and budget positions into deficit across the Gulf, but these can be financed from large savings for some time. Dollar pegs should stay intact and the Gulf won’t backtrack on plans to raise output.

“That said, fiscal austerity is likely to be stepped up, and growth in non-oil sectors will be weaker than we had previously thought both this year and next.”

The kingdom also has dozens of millions of barrels of crude stored in strategic reserves to be used when needed and is expected to use it to provide the extra barrels to the global market.

With demand remaining uncertain considering the economic impact caused by the coronavirus, any significant increase in supply would mean producers have to compete amongst each other to retain/increase market share.

Ranjith Raja, oil research manager, Middle East and North Africa, Refinitiv, said: "This has historically led to price cuts and the first semblance of price cuts returning to the market was witnessed over the weekend when Saudi Arabia cut the Official Selling Prices (OSP) for April sales of crude oil to all key demand markets in the range of $5-8/bbl.

“This has already led to reported interest from a few Asian buyers who are looking at the possibility of increasing sourcing of crude oil from the region as prices are set to fall. Russia, with pipeline access to China and USA with the advantage of trade deal negotiations have a competitive advantage for supply into the key Chinese market and hence Middle Eastern producers would need to be extremely competitive on their pricing while also focussing on other key Asian consumers. Other regional producers are expected to follow suit on their pricing and target market."

Global oil demand has never dropped as fast in its 150-year history as has happened in the last month. While in the last 40 years, demand has only declined year-on-year twice (2008 and 2009), 2020 is likely to be the third time.

Welch said: “Dated Brent oil price in 2019 averaged $64/bbl, it is almost certain that the 2020 average will be below $60/bbl and possible that it will be below $50/bbl.”

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