Why the OPEC-Russia Blowup Sparked All-Out Oil Price War

(Bloomberg) -- A petroleum price war exploded in March after the dramatic collapse of an alliance between the OPEC cartel and Russia, a pact that had underpinned world oil markets for three years. In the days that followed, the price of oil plunged more than 50%, sending shockwaves through a global economy reeling from the fallout of the coronavirus pandemic. The mayhem gave birth to an historic truce, bringing together OPEC and countries from the Group of 20 nations that have long criticized the cartel. Still, the production cuts they agreed to likely won’t be enough to offset the deep slump.

1. What triggered the problem?

Russia and nine other countries had joined forces with the 13-member Organization of Petroleum Exporting Countries in 2016. The group, dubbed “OPEC+,” controlled almost half of the world’s oil production and led to a resurgence of the cartel. The blowup came after Russia refused to go along with production cuts pushed by Saudi Arabia at a March 6 meeting in Vienna. The kingdom -- OPEC’s biggest producer and its driving force -- wanted to trim output to prop up prices as the coronavirus ravaged demand. The fight prompted Saudi Arabia’s state-owned oil behemoth to temporarily reverse course and open the taps.

2. What led to the rethink?

As the pandemic stretched on, there were estimates that it could knock out as much as a third of global oil demand. The slump in prices threatened millions of jobs and the political stability of oil-dependent nations. On April 2, U.S. President Donald Trump called for a coordinated production cut, becoming the first U.S. leader in decades to move to drive up the price of oil. What emerged was an unprecedented agreement to cut global oil production by nearly a 10th, which included contributions from oil producers in the G-20 states that have long railed against OPEC’s control of the world’s most critical commodity. While the plan puts an end to the immediate price war, it’s not likely to go far enough to offset the impact of the pandemic on world oil demand.

3. How did we get here?

Russia didn’t want to be strong-armed into further cuts to its lucrative oil production. It complained that its three-year deal with OPEC, which has been managing global oil supply since 1960, had aided America’s shale industry. Russia was also increasingly angry with Trump’s willingness to employ energy as a political tool. It was irked by the use of U.S. sanctions to prevent the completion of a pipeline linking Siberia’s gas fields with Germany, known as Nord Stream 2.

4. What does this have to do with shale?

The Kremlin was reluctant to cede further market share to U.S. shale drillers -- known as frackers -- that have been adding millions of barrels of oil to global markets. An attack on shale has been tried before: When the new technique was expanding in 2014, Saudi Arabia’s strategy was to flood the market, expecting that a collapse in prices would thwart the new competition. As shale producers found cheaper ways to operate and a global supply glut dragged on, OPEC then returned to its traditional tool of constraining output, sending oil to a four-year high of more than $85 a barrel by mid-2018. OPEC’s success in lifting oil prices proved self-defeating. Higher prices re-invigorated U.S. fracking, propelling the U.S. past Saudi Arabia and Russia as the world’s No. 1 crude producer.

5. Can the U.S. live with lower prices?

Many drillers in Texas and other shale regions look vulnerable, as they’re heavily indebted and already battered by rock-bottom natural gas prices. The price of oil tumbled to less than $25 a barrel in the days following the OPEC+ bustup. That prompted some old-guard Texas oil drillers to urge state regulators to clamp down on crude production for the first time in nearly half a century in a coordinated effort with Saudi Arabia and Russia to calm the market and stave off a total industry meltdown.

6. What about Russia and Saudi Arabia?

In the short run, Russia is in a good position: Its budget breaks even at a price of $42 a barrel and it has squirreled away billions of dollars in a rainy-day fund. Saudi Arabia, which is almost entirely dependent on oil to fund government spending, holds about $500 billion in foreign currency reserves as a cushion. OPEC has a built-in competitive advantage, since its Middle Eastern members can produce crude at about a third of the cost of U.S. shale.

7. What about other countries?

Such a dramatic crash in the price of oil, if it were sustained, would savage national budgets of petro-states from Venezuela to Nigeria to Iran, threatening to upend politics around the world. Volatile oil prices are an added complication as policy makers try to shield economies from the impact of the coronavirus epidemic.

8. What’s the wider fallout?

There are winners from rock-bottom oil prices -- among them China, the world’s largest oil importer, whose recovery from the virus will be key for the global economy. The U.S. -- once a beneficiary of low oil prices -- is now an exporter rather than a buyer. Sudden surges in oil prices are feared because of the way they could jack up costs across the global economy and slow economic growth. Now a world reeling from an economic slump triggered by the virus is enduring another sort of oil shock.

The Reference Shelf

• A commissioner at the oil regulator in Texas argued for intervention to save the U.S. shale industry.
• Bloomberg Businessweek on Saudi Arabia’s high-stakes plan to win the global oil war.
• Why Russian President Vladimir Putin wanted a war on shale.
• Julian Lee from Bloomberg opinion argues that to save shale, Trump must exercise the art of the deal.
• How Russia’s deal to align with OPEC in 2016 nearly failed.
• QuickTakes explain how OPEC has continually defied its critics, why the world frets about Russia’s Nord Stream 2 pipeline, and the Texas oil regulator.

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