A sea of red blanketed the screens of stock market floors across Asia, Europe and the United States on Monday in the worst trading day since the 2008 financial crisis, with the DOW suffering its biggest point drop in history. The crash, now dubbed “Black Monday,” was the culmination of market jitters associated with COVID-19, and rapidly tanking oil prices, which dropped as much as 34 percent in trading before stabilizing at losses of about 20 percent.
By the end of Monday’s bloodletting, Brent was trading at $36.12, and West Texas Intermediate (WTI) was down to $32.98 a barrel. A sense of comparative calm returned to energy markets the next day, with Brent bouncing back 10 percent to $37+ a barrel, and WTI up to $33+ for April futures in Tuesday morning trading.
What happened? It all started on a cool, grey day in Vienna, Austria on Friday, where officials from the Organization of the Petroleum Exporting Countries, as well as Russia, Kazakhstan, Oman, Mexico and half a dozen other non-OPEC oil producing nations met to discuss the global oil situation amid new coronavirus-related fears of a global economic slowdown.
At the meetings, according to Reuters, OPEC ministers backed an additional 1.5 million barrels per day (bpd) in cuts through to the end of 2020, on top of the 2.1 million bpd cuts already in place, for a total of 3.6 million bpd, or 3.6 percent of global oil supply.
Russian Energy Minister Alexander Novak, for his part, said Russia could agree only to extend the existing (2.1 million bpd) OPEC+ cuts. In response, OPEC ministers reportedly refused to extend even its own proposals on cuts, and the rest quickly became history.
Gremlins From the Kremlin?
Bloomberg put its own spin on the story, alleging that the failure of the talks was really all Vladimir Putin’s fault. According to the news agency, the plunge in prices was the result of the Russian president “dumping” Crown Prince Mohammed bin Salman and the Saudis “to start a war on America’s shale oil industry.”
Speaking to Bloomberg, Alexander Dynkin, president of the Institute of World Economy and International Relations in Moscow, said that the Kremlin had “decided to sacrifice OPEC+ to stop US shale producers and punish the US for messing with Nord Stream 2. Of course, to upset Saudi Arabia could be a risky thing, but this is Russia’s strategy at the moment – flexible geometry of interests.”
The Worse, the Better
Other observers, including economist and Sputnik contributor Ivan Danilov, aren’t so certain of this version of events.
Russia, Danilov notes, was not responsible for “undermining” or “breaking” anything as far as world oil markets are concerned. By and large, he argues, the maneuver applied by Moscow’s OPEC+ partners was an attempt to apply “the well-known strategy in relation to Russia of ‘cutting off one’s nose to spite the face’.”
“The situation, based on Reuters data, should be described again in simple terms: Russia proposed leaving things as they were, without succumbing to panic [over COVID-19] But instead of seeking a compromise, OPEC representatives (with the main role likely played by Saudi Arabia) decided that instead of a compromise, it was necessary to ‘stand on principle’ and destroy even what Russia had suggested to keep in place, and then to make things even worse, and in such a way as to make things as bad as possible for everyone.”
According to Danilov, the magnitude of Monday’s oil market drop was likely the result of the fact that no one expected such an insane scenario to play out at all, with the worst-case scenario for prices before Friday being simply maintaining existing supply cuts.
“Saudi Arabia has earnestly tried not only to collapse the market, but to do so as painfully as possible for the whole world, and not just for oil-producing countries,” the economist believes. “Not only did Riyadh announce that it would sell April oil with a ten dollar discount below stock price, but reports also emerged that the country was ready to increase production by as much as three million barrels per day.”
Race to the Bottom
Danilov argues that it’s possible that Riyadh genuinely believes that Russia’s economy will collapse as a result of low oil prices, and that such fears will force Moscow to change course, but the reality of the situation is the exact opposite of the oil kingdom’s calculations.
On Monday, Russia’s Finance Ministry reported that the country’s rainy day sovereign wealth fund had accumulated enough liquidity in the form of $150 billion to compensate for lower state revenues from oil even if prices remained at the $25-$30 mark for up to a decade.
Meanwhile, given the fixed exchange rate between the Saudi riyal and the US dollar (the rate has been fixed at 3.75 riyals per USD since 1986), the plunge in oil prices threatens to eat up Riyadh’s $501 billion exchange reserves quickly, particularly given the kingdom’s other problems, including a $50 billion budget deficit, and dependence on oil for 87 percent of its state budget.
“By comparison,” Danilov notes, “Russia looks like a model of financial stability – with a deficit-free budget, floating exchange rate, and oil and gas revenues as a percentage of budget revenues of 40.8 percent.”
Accordingly, while Russia won’t survive the global oil glut entirely unscathed (with lower oil prices and a dropping dollar-ruble exchange rate meaning higher prices for imports such as automobiles, electronics and trips abroad) its outlook is better than that of most OPEC members, not to mention US shale. In fact, Danilov argues, the current situation not only threatens the Western developed economies with deflationary shocks, but poses a threat to the survival of the entire US oil and gas sector, which contributes about 7 percent of America’s GDP, and accounts for over 10.3 million jobs.
Ultimately, Danilov suggests that although it’s entirely possible that the interested parties will find an acceptable way out of the current crisis – perhaps at the next OPEC+ Joint Technical Committee meeting presently being floated to take place as soon as next Wednesday, Russia, unlike some of its partners, “is quite capable of surviving a period of turbulence in financial markets, even if it turns out to be much longer.”