Anyone who drives these days has noticed the drop in gasoline prices at the pump lately. No doubt we’re all happy about that. But what is actually behind the dip? And is that back story really good news for America?
Over the last several years, the ingenuity of American oil producers gave us the technology to recover oil trapped in deep underground shale rock formations. Then President Donald Trump relaxed onerous federal regulations that had limited drillers’ ability to deploy such methods. The result was a boom in U.S. oil production which rose towards 13 million barrels per day at the end of 2019, with exports over 3 million barrels per day (mbpd). The U.S. became the largest producer of oil in the world.
That extra U.S. oil production meant that there was a lot more oil flooding world markets than before our fracking revolution. More available product means lower prices. Those prices have now dipped to the low $30-upper-$20-per barrel range.
For other major world oil producers, this development was not met with the same joy as here at home. In particular, both Russia and Saudi Arabia began feeling a significant amount of fiscal pain. Russia’s oil production break-even point is in the mid-$40s, while Saudi Arabia needs over $80/barrel to break even. U.S. shale oil producers need just $22/barrel. That is why Moscow and Riyadh teamed up in 2017 to limit supply in an attempt to prop up prices. And that worked for them for a while.
But then came the coronavirus and worldwide demand for petroleum products plummeted. Early February 2020 saw global oil producers in urgent negotiations to cut production to stabilize prices. It seemed for a while that agreement might be reached, but then Russia balked and refused to continue negotiating a production cut deal because Moscow said it was impossible to know what the ultimate impact of the coronavirus would be. Already pressed hard by U.S. shale oil production, though, Moscow’s sudden intransigence betrayed an even deeper fear: that it would lose market share if it cut production (a step it’s rarely ever taken), thereby holding steady or raising oil prices worldwide.
By early March 2020, Saudi Crown Prince Mohammed bin Sultan (MBS) decided to call Russian President Vladimir Putin’s bluff. The Saudis signaled they would immediately slash prices and increase daily oil production by 2 mbpd. Whether or not this was even feasible, world oil markets reacted in shock and prices dropped by a third literally overnight. Big oil companies worldwide registered alarming drops in their market value. That includes U.S. producers—because when we were still a net oil importer, lower prices would have been welcome news. But now that the U.S. is a net oil exporter, the calculus has changed. Still, with its lower break-even price point, the U.S. oil industry is better placed than either Russia or Saudi Arabia to ride out the spat. Additionally, the Trump administration’s swift steps to support the U.S. domestic oil industry—specifically by suspending sales from the Strategic Petroleum Reserve (SPR), and instead putting out bids to top off the SPR along with encouraging banks to extend loans or allow delayed payments on old ones—should create demand and go a long way to cushion the blow, even for the smaller U.S. producers. Meanwhile, for the average American consumer, facing tough financial times during the coronavirus pandemic, continued lower gasoline prices are a welcome bright spot.
As of late March 2020, there seemed to be no end in sight to the Russian-Saudi oil price war, as each side digs in to make the other side blink first and preserve its own market share. Ambitious spending plans by both Putin and MBS will have to be scaled back, if not put on hold. Perhaps fortuitously, this would include spending on Middle East battlefields. Russia has built up substantial financial reserves, but it’s unavoidable that it will have to tap into its foreign currency reserves to cover oil price shortfalls. Nevertheless, Moscow thus far has been willing to suffer short-term pain in a gamble that it will be the winner in the longer term. The Saudis also have a certain financial cushion amounting to some $502 billion in reserves. But recall that its break-even price point is $80/barrel; so, even an oil price recovery to the $45-$55 range by late 2021 would be far less bearable for the Saudis than for the Russians. Already by 19 March 2020, Saudi Finance Minister Mohammad al-Jadaan had announced a 5% spending cut.
In response to all of this, the Trump administration reportedly is considering intervening in the Saudi-Russian oil price war. Efforts may include a “diplomatic push to get the Saudis to cut oil production and threats of sanctions on Russia aimed at stabilizing markets.” Moscow apparently viewed that prospect with some alarm as Kremlin spokesman Dmitry Peskov hastened to disclaim there even was any price war with the Saudis. Of course, the last thing Russia wants is for oil production in both of its top global competitors to stabilize and survive. In any case, the U.S. is probably best positioned of all to come through in good shape.
This column was originally published at Citizens Commission on National Security.
The views expressed in CCNS member articles are not necessarily the views or positions of the entire CCNS. They are the views of the authors, who are members of the CCNS.