Saudi Arabia and Russia are threatening to flood the world oil market with 24 million barrels a day as price war escalates

Saudi Arabia escalated its oil price war with Russia on Tuesday, with its state-owned company pledging to supply a record 12.3 million barrels a day next month, a massive production hike to flood the market.

The supply increase — more than 25 per cent higher than last month’s production — puts Aramco supply above its maximum sustainable capacity, indicating that the kingdom is even tapping its strategic inventories to dump as much crude, as quickly as possible, on the market. In February, Saudi Arabia produced about 9.7 million barrels a day.

Welcome to the free market. The world is about to learn very swiftly how important a swing producer is for stability

Bob McNally, founder of consultant Rapidan Energy Group

It’s the latest manoeuvre in what’s set to be a long and bitter conflict between Russia and Saudi Arabia. On Monday benchmark oil prices fell more than 20 per cent, the largest one-day drop in almost 30 years, creating mayhem in global equity and bond markets.

Oil prices initially pared gains on Tuesday, but later resumed its advance amid a broader rally in global markets. Brent crude was trading 9.4 per cent higher at US$37.54 a barrel at 10:49 a.m. in London. The benchmark plunged 24 per cent on Monday, the biggest drop in almost 30 years.

Moscow responded within minutes in what looked like a war of words, with Alexander Novak, the country’s energy minister, saying Russia had the ability to boost production by 500,000 barrels a day. That would put the country’s output potentially at 11.8 million barrels a day — a record.

War Strategy

The outcome of the price war will be determined by Saudi Arabia and Russia’s ability to inflict damage, but also their ability to absorb it.

Saudi Arabia has greater offensive abilities, thanks to about 2 million barrels a day of idle production capacity. Riyadh can also use its strategic oil stocks to boost supplies at very short notice, according to people familiar with its strategy.

On top of domestic stockpiles, it also stores crude near consumption hubs in Rotterdam, Okinawa and the Egyptian port of Sidi Kerir. Russia doesn’t have a network of strategic oil stocks to match.

Russia may have the defensive advantage. The Kremlin can dip into its US$150 billion wealth fund to offset the slump and bolster the ruble. Those reserves are sufficient to cover lost revenue “for six to 10 years” at oil prices of US$25 to $30 a barrel, the Finance Ministry said.

Should Brent crude remain at US$35 without an adjustment in Saudi spending, the kingdom would run a deficit of nearly 15 per cent of economic output in 2020, while its net foreign reserves could run out in about five years unless it uses other funding sources, according to Abu Dhabi Commercial Bank.

Free Market

“Welcome to the free market,” said Bob McNally, founder of consultant Rapidan Energy Group and a former White House official. “The world is about to learn very swiftly how important a swing producer is for stability, not only for the global oil market but the broader economy and geopolitics.”

For decades, the oil market has been largely regulated. First by Americans, who set production quotas for their oil companies through the Texas Railroad Commission in the first half of the 20th century, and later by the Organization of Petroleum Exporting Countries, the oil cartel. Through that time, Texas and later OPEC acted as swing producers, upping output at times of scarcity and reducing it at times of lower demand, to keep prices stable.

With oil demand rapidly falling due to the economic impact of the coronavirus epidemic, the Saudi production hike, followed potentially by another one from Russia, is likely to force oil companies to store crude, rather than process it. Traders are already seeking out tankers to store the glut.

The International Energy Agency earlier this week said that global oil demand will contract this year for the first time since the global financial crisis in 2009.

The U.S. and other Western countries are starting to worry about the oil price war between two of the world’s most powerful petroleum nations. On Monday, the U.S. Department of Energy denounced in a rare statement “attempts by state actors to manipulate and shock oil markets”.

Even as both sides ramped up production and the war of words, Novak said the door wasn’t closed to future talks. He said OPEC+ could meet in May or June.

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