Power in Pandemics by J Reills

Power in Pandemics: Can Big Oil Reach a Deal? Jacqueline Reilly Stockton University

INTRODUCTION Amidst the current global public health crisis, many industries have been crippled,

contributing to the looming economic crisis. Economies are contracting as millions lose their jobs during the COVID-19 pandemic. This has affected international trade by slowing it significantly. As domestic and international travel have essentially halted, the oil industry must reckon with reality. The nature of this essay is to examine the economic and geopolitical implications as leaders across the globe seek to mitigate the damage and reach an agreement. I will also explore the unprecedented decrease in demand and increase in supply and what it means for the oil industry. II.

BRIEF HISTORY While cartels may be illegal domestically, international enforcement is rather difficult to

coordinate and effectively carry out. One of the most successful cartels is the Organization of the Petroleum Exporting Countries (OPEC), made up of 23 countries including Saudi Arabia (the de facto leader), Iran, Iraq, and Venezuela. The OPEC website states their objective is “to coordinate and unify petroleum policies among Member Countries, in order to secure fair and stable prices for petroleum producers; an efficient, economic and regular supply of petroleum to consuming nations; and a fair return on capital to those investing in the industry.” (“Brief History”). A decade after its foundation in 1960, OPEC’s international prominence (brought on by member nations taking control over sovereign crude oil production) granted it more influence on pricing in the world markets. This influence would be evidenced at the expense of the U.S., in two periods during the 1970s.

The Arab oil embargo of 1973 and the Iranian Revolution in 1979 rejected prior U.S. actions. This was primarily due to U.S. intervention in the Middle East (stretching back to the 1950s) as well as the devaluation of the dollar, which occurred when President Nixon took it off the Gold Standard (“Brief History”). The repercussions came in the form of a supply shock, putting upward pressure on prices. Both events contributed to the condition known as stagflation (i.e. the combination of stagnation and inflation, i.e. increasing prices) which persisted throughout the 1970s. Following the energy crisis the U.S. faced in the previous decade, the 1980s brought an oil glut due to a surplus of crude oil and falling demand. Many member countries of OPEC endured economic hardship as a result. Throughout the next couple of decades, attributable to the price inelasticity of oil, OPEC’s market share grew, and prices leveled out over time. The early 2000s saw a period of high prices that were effectively negated by the global financial crisis of 2009. As oil prices plummeted again, OPEC stepped up to provide support for the oil industry in order to alleviate the economic impact (“Brief History”). The markets became stable for a three-year period (2011-2014) following the global financial crisis but was faced with shifting trade patterns. These shifts are attributed to the climate crisis and the interest of many nations to cut back on fossil fuels or explore renewable sources of energy (see Appendix A). Most recently, the COVID-19 pandemic has leveled the oil industry with a demand shock, causing prices to fall significantly. III.

PRICE WAR The drop in prices, coupled with the dramatic increase in supply, questioned the future

demand for oil because there was no certain resolution to the pandemic in sight. As demand

continued to decrease in the beginning of 2020 (caused by lockdowns ensuring less domestic and international travel), OPEC was scheduled to meet in Vienna in early March to discuss production cuts. When the meeting concluded on March 6, a deal had not been reached to cut production, with Russia refusing OPEC’s terms. This decision was a response to Saudi Arabia calling for even more production cuts than were anticipated. Both nations also were reluctant to cut their supply if the U.S. did not also agree to do so. Following Russia’s refusal of the terms of the agreement, Saudi Arabia, in an attempt to showcase power (we will examine the politics of these decisions in the following sections), the state-owned Saudi Aramco increased production, dropping prices further, and offered additional discounts. As oil companies across the globe reckon with the demand shock, the potential economic and political ramifications are entangled with this oil price war. IV.

ECONOMICS The economic impact underpins the broader geopolitical landscape as it relates to the oil

industry. Saudi Arabia’s response to Russia refusing their terms was to increase their production 25% more than what they had produced a month prior. Russia followed suit, boasting they too would ramp up production. Prices dropped by 24% and the price per barrel to $34 (Economist). Demand for oil was dropping at a reported 8 million barrels a day in the U.S. Appendix B depicts the U.S. oil prices plummeted from over $60 per barrel in December 2019 to $20 a barrel just three months later. Saudi Arabia and OPEC were floating cutting supply by 10 million barrels a day in an effort to put a floor on oil prices. While supply cuts are essentially nullified by the demand shocks induced by the pandemic, they help to mitigate the economic impact.

The effects of globalization are clear here, as the interconnectedness of the oil industry is being felt across the world. The U.S. stands to lose the most, as it is currently the top producer of crude oil (giving it a coveted position of power). There are 10 million jobs attached to the industry (Krauss). These American jobs hang in the balance as OPEC struggles to make a deal. V.

GEOPOLITICS OPEC’s mission is to organize oil suppliers to undertake coordinated policies in order to

maximize the collective profits of its members. Simultaneously, countries are jockeying for the upper hand. Naturally, it is a complex world to navigate agreeable terms and ensure cooperation: OPEC had been playing an increasingly complex game requiring it to not only weigh market fundamentals (supply, demand, stock levels, etc.) but also to gauge geopolitical factors involving U.S. sanctions (against Iran, Venezuela, and Russia); a U.S.-led trade war with China; the divergent interest of various OPEC members, including the bromance of convenience between Saudi Arabia and Russia; and a fundamentally new paradigm for the oil market… (Ladislaw) Russia, Saudi Arabia, and the U.S. are struggling to maintain market share and minimize the impact on their respective economies. As of today, the U.S. is the top producer of crude oil (owing to the “shale revolution”), followed by Saudi Arabia and Russia (Economist). The matter at hand is how much oil output each nation will be cutting, potentially impacting market shares. Before the scheduled OPEC meeting, Russia was uncertain of the necessity of cutting supply so steeply and was reluctant to assist U.S. shale producers (Bordoff). Additionally, the

U.S. had previously imposed sanctions on Russia for two reasons: 1) their dealings with Venezuela, and 2) to delay the state controlled Rosneft’s pipeline to Europe. Appendix C illustrates how increased U.S. production of crude oil, called shale oil, has overtaken the market. Prior to the COVID-19 pandemic, American oil companies were on track to continue growing. With the U.S. vulnerable (owing to falling oil prices) and eager to reach some agreement to stabilize the markets, Russia saw an opportunity. The U.S. oil industry is tied to roughly 10 million jobs. Regardless of any supply cuts, the U.S. will face additional economic consequences that could devastate oil-producing regions, such as west Texas. Russia viewed Saudi Arabia’s calls for even lower supply cuts as an ultimatum - agree or prices will continue to drop. They walked away from OPEC without having negotiated an agreement. Saudi Arabia flexed its economic power the following day, calling Saudi Aramco to increase production, cutting prices further. Jacob Bordoff details five potential ramifications of the ensuing price war in his article for Foreign Policy. One, would this decision push Russia further away from negotiating? Neither country can afford a sustained period of low prices, but Saudi Arabia risks losing credibility if they acquiesced before Russia. Second, OPEC’s credibility could be damaged if they are unable to make a deal. Political instability and sanctions make coordination between members and non-members of OPEC difficult. On top of that, the shale revolution was cutting into OPEC’s market shares leaving members at risk. Third, the U.S. could be most negatively impacted. Even before the meeting, shale firms were struggling with the slowdown in production, due to lockdown procedures being enacted across the country. Fourth, the U.S. has gained strength on both the economic and geopolitical fronts because of the shale revolution. For an adversary such as Russia to attempt to take down the U.S. indicates the U.S. position as top producer is vulnerable to low prices, owing to the expensive nature of shale

production. Finally, the economic crisis that is occurring in tandem with the decrease in demand implies that the results are not likely to follow past patterns. Specifically, that price cuts will not give the same boost in GDP as it may have prior to the pandemic. The oil producing regions in the U.S. will be the most economically impacted (Bordoff). China, on the other hand, may benefit from the oil price war. There are two reasons for this: not only is China the biggest importer of crude oil, but they also have a tremendous storage capacity (Downs). Having the ability to buy while oil prices are low and the ability to store it benefits the Chinese. Storage of the oil being produced is vital because there is very little demand. In turn, low demand for oil spurs demand for storage (preferably at a cheap rate). VI.

THE DEAL: SHORT-RUN & LONG-RUN After much speculation regarding the oil price war, an agreement was reached this

weekend. Announced by President Trump on April 12, production will be cut by 9.7 million barrels per day. Kuwait (another member of OPEC) along with others claim that the number will be closer to 20 million barrels per day. This higher number operates under the assumption that non-members of OPEC will also cut supply in order to stabilize the price and markets for all (Russell), thus increasing the production cuts. Non-member participation in this agreement is going to be a vital part of its success, though, as previously mentioned, international compliance is difficult and many countries cheat. Under normal conditions, the reduced supply would help bring the markets to equilibrium by spurring on demand (Krauss). However, this cannot occur with the current lockdown policies. The long-term production cuts aspire to be more successful, with supply cuts scheduled to increase over 6-month periods, lasting until 2022. If there is cooperation amongst nations, this could be effective as the economy tries to restart after the pandemic. Countries in Africa, Latin

America, and the Middle East are likely to face greater economic hardship and potential political ramifications following the drop in price levels. VII.

CONCLUSION The rise of globalization has contributed to the economic success of many countries, but

it has also brought new risks. As companies become increasingly more reliant upon one another, the economic fallout is felt everywhere, not just in one place. The COVID-19 pandemic has created a harsh economic environment that is being felt across the globe. While OPEC was able to negotiate a tentative agreement, its effectiveness will only be known after the pandemic subsides and economies can begin to rebuild.

Works Cited

Bordoff, Jason. “Why This Oil Crash Is Different.” Foreign Policy, 9 Mar. 2020, foreignpolicy.com/2020/03/09/opec-russia-shale-oil-price-collapse/. “Brief History.” OPEC, www.opec.org/opec_web/en/about_us/24.htm. Downs, Erica, et al. “SIPA Center on Global Energy Policy.” Columbia, 25 Mar. 2020, energypolicy.columbia.edu/research/commentary/china-and-oil-price-war-mixedblessing. Faucon, Benoit, and Summer Said. “Saudi-Russia War of Words Delays Oil-Truce Talks.” The Wall Street Journal, Dow Jones & Company, 4 Apr. 2020, www.wsj.com/articles/saudirussia-war-of-words-delays-oil-truce-talks-11586001480? emailToken=8faf1aa3c2d03555b6018d97832d21b00otDm1FFsTyMKYucCxpXd8XTIY3 18ovAghR1KHCFCPziPrQFzkUfp%2FUV %2BuvriZpy4CrpArLy4Afr6fPyiddxWx6fNwBRWADy%2F6Dkxn5MXCM %3D&reflink=article_email_share. IEA, Global oil demand growth, 2011-2025, IEA, Paris https://www.iea.org/data-andstatistics/charts/global-oil-demand-growth-2011-2025 Krauss, Clifford. “Oil Nations, Prodded by Trump, Reach Deal to Slash Production.” The New York Times, The New York Times, 12 Apr. 2020, www.nytimes.com/2020/04/12/business/energy-environment/opec-russia-saudi-arabiaoil-coronavirus.html.

Krauss, Clifford. “The Big Deal to Cut Oil Production May Not Be Big Enough.” The New York Times, The New York Times, 13 Apr. 2020, www.nytimes.com/2020/04/13/business/economy/coronavirus-oil-opec-trump.html. Ladislaw, Sarah. “Oil Price War.” Oil Price War | Center for Strategic and International Studies, 9 Apr. 2020, www.csis.org/analysis/oil-price-war. Ng, Abigail. “5 Charts That Explain the Saudi Arabia-Russia Oil Price War so Far.” CNBC, CNBC, 1 Apr. 2020, www.cnbc.com/2020/04/01/5-charts-that-explain-the-saudi-arabiarussia-oil-price-war-so-far.html.

Appendix A

Appendix A depicts previous demand for oil and a five-year forecast of what that demand may look like (IEA). This downward trend in the demand for oil is exacerbated by the COVID-19 outbreak in 2020 and accompanied by a shift in the environmental policies to mitigate the looming climate crisis.

Appendix B

Appendix B shows the declining price per barrel of two major American producers of shale oil. It also depicts the market reaction when Russia balked on a supply cut agreement (Ng).

Appendix C

Appendix C depicts the shale revolution, which is the reason for a growing U.S. market share prior to the COVID-19 pandemic (Ng). Russia and Saudi Arabia’s fight over production cuts can be attributed to this dynamic in the global oil industry.