While the United States is reeling under the economic effects of COVID-19, there is another crisis looming large on the US economy. This crisis faced by the US shale industry threatens to drive most of the US’ unconventional oil and gas producers into imminent bankruptcy. When millions of people are filing for unemployment benefits in the US as a result of the pandemic-linked furloughs and layoffs, the crisis that hit the shale industry is adding to the unemployment figures. It is to be noted that the shale industry is the leading employment provider in states like Texas, North Dakota, New Mexico, Louisiana, and Oklahoma. Oil industry expert Daniel Yergin contended that troubles in the shale industry will also be felt throughout the Midwest, as the region supplies the shale industry with key industrial inputs.
So, what caused the sudden downturn in the fortunes of the US shale industry, which until last year had been showing no signs of contraction? The reversal of fortunes was triggered by the price war between Saudi Arabia and Russia- the world’s second and third-largest oil producers, respectively. This price war produced a glut in the global oil market, leading to tanking of the oil prices to as low as $22 per barrel in April. Goldman Sachs warned in early March that if the trend continues, the oil prices might fall below $20 per barrel, which will be the lowest in two decades. When the crude demand plunged throughout the world as a result of the COVID-19 pandemic triggered an economic shutdown, the price war has added to the troubles of oil-revenue dependent economies.
Background to the Price War
The global oil market is dominated by the Organization of the Petroleum Exporting Countries (OPEC) countries, led by Saudi Arabia. The cartelization that happened in the 1970s was an expression of ‘oil power’ by the crude producers vis-a-vis the consumers. The OPEC countries, especially Saudi Arabia, had a greater influence over the price of crude oil, as they could expand or shrink production depending on the market condition. This power over managing crude prices is, however, restricted by the limited membership of the cartel. The OPEC membership does not include major crude producers like Russia, and other minor producers like Mexico, Bahrain, and Malaysia. However, being the world’s third-largest producer of crude oil, the Russians have as much power as the OPEC to swing the oil price for geopolitical reasons. It is to be noted that stability in the world oil prices benefits not only the importers but also the exporting countries. This fact is acknowledged by both Saudi Arabia and Russia, as they do not intend to rattle the oil market too often.
In 2015, reminiscent of the ongoing oil price war, Saudi Arabia caused a glut in the global oil market, forcing the prices to fall below $50 per barrel. In a breakthrough, a historic deal was signed in 2016 between the OPEC and non-OPEC oil-producing countries (together called OPEC+) to put a freeze on oil production. The current price war was triggered when Russia refused to abide by the agreement to limit crude output in response to the global slump in demand. The Saudis responded by increasing its own crude output to 12 million barrels per day and also by selling it to the European markets at a 10 percent discount.
Rationale behind the Russian move
Russian actions defy any logic unless it is viewed in the context of the booming shale production in the US. The US shale is undercutting other global oil producers’ hold over their traditional markets. For the US shale industry to break even, the price of the crude has to remain above $40 per barrel. The production ceiling agreed by the OPEC+ members in 2016 ensured that the price of the crude remains above this threshold. Hence, some people in President Vladimir Putin’s inner circle contended that the US shale industry would be the one to benefit the most from the Saudi-Russian deal. Therefore, they urged President Putin not to limit production, whatever the costs to the Russian economy might be. Russia’s recent decision not to limit oil output despite the global demand contraction is a victory for this particular group of hardliners. Some even argued that Russian behavior is in response to the US sanctions against Rosneft Trading for its support in selling Venezuelan oil.
Emergence of OPEC 2.0?
As President Trump touted the energy independence of the United States and freedom from the manipulations of Saudi Arabia and other oil producers, the price war has brought to light a stark reality. Given its free-market predispositions, it is unlikely that the US will remain shielded from any future price wars. However, while the US fought for lower oil prices and production increase in the past, it is time to tussle for the opposite outcome. The deal brokered by President Trump between Saudi Arabia and Russia in early April was aimed at achieving such a result. The deal also signals the emergence of a new era in which the US along with Saudi Arabia and Russia will be determining the future price of oil.
** The author is currently pursuing his Ph.D. as a Junior Research Fellow (JRF) in the Centre for Canadian, US, & Latin American Studies, School of International Studies, JNU ***
