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Saudi Arabia launches an oil war

  • Category
    India & world
  • Published
    18th Mar, 2020

Saudi Arabia has started an incredible price war with Russia by slashing its selling prices and pledging to unleash its pent-up supply onto a market reeling from falling demand because of the coronavirus outbreak.

Context

Saudi Arabia has started an incredible price war with Russia by slashing its selling prices and pledging to unleash its pent-up supply onto a market reeling from falling demand because of the coronavirus outbreak. Crude oil price plunged by 30% after the announcement and Bitcoin fell by 8%. 

Background

  • Stock futures sank deep into the red with the US exchanges expected to crash as a new oil war sparked by the coronavirus outbreak sent prices plummeting. 
  • Saudi Arabia slashed its export oil prices over the weekend in what is likely to be the start of a price war aimed at Russia but with potentially devastating repercussions for Russia’s ally Venezuela, Saudi Arabia’s enemy Iran and even American oil companies. 
  • The Saudi decision to cut prices by nearly 10 percent is a dramatic move in retaliation for Russia’s refusal to join the Organization of the Petroleum Exporting Countries (OPEC) in a large production cut as the coronavirus continues to slow the global economy and, with it, demand for oil. 
  • The cut added further uncertainly to global markets already roiled by the coronavirus. 
  • A major drop in oil prices would hurt producers around the world, particularly Venezuela and Iran, whose oil-based economies are already under pressure from American sanctions. 
  • Export earnings of both countries have already been reduced to a trickle, and a further decline would stretch their abilities to pay for vital services and security. 
  • The importers, on the other hand, have suddenly got a windfall. 

Analysis

Why is Saudi Arabia doing this? 

  • The turmoil comes after the implosion of the oil alliance between OPEC and Russia. 
  • Russia refused to go along with OPEC's efforts to rescue the corona virus-battered oil market by cutting production. 
  • The failure of the Vienna meeting left the oil industry shell-shocked, sparking a 10% plunge in oil prices even before the Saudi declaration of war. 
  • Oil prices were already stuck in a bear market because of the coronavirus outbreak that has caused demand for crude to fall sharply. 
  • Russia's refusal to cut production was aimed at piling up more losses on US shale oil producers, many of which need higher oil prices to survive. 
  • Russia has been dropping hints that the real target is the US shale oil producers because it is fed up with cutting output and just leaving them with space.
  • However, the US shale industry emerged from that period stronger and the United States would eventually become the world's leading oil producer.
  • Saudi Arabia is a staunch US ally. This is an extra-ordinary geopolitical situation. 
  • Saudi Arabia badly wanted oil prices to rise to bolster a struggling economy. 
  • Russia refused to boost oil prices to hurt the American shale industry. 

 When can this damage the US shale industry? 

  • The shale revolution was made possible by the combination of horizontal drilling and hydraulic fracturing (fracking). 
  • In the early 2000s fracking technology began to be broadly applied to reservoirs that had been viewed as being uneconomic for the previous 100 years or so. 
  • Proclaimed as a miracle, oil imports from traditional sources dropped, and oil exports to foreign markets grew. 
  • Along with this shifting of export and import polarity, came the sentiment that the U.S. was now the swing producer of crude oil and would quickly fill any gaps left by other producers. 

 Where will this move most likely lead to? 

  • Oil prices had begun to weaken as shale oil production continued to expand, so OPEC decided it needed to act to protect market share. 
  • This put OPEC in the cycle of having to cut production again and again as shale production kept climbing. 
  • On the other hand, in Saudi Arabia, where the government is almost entirely dependent on oil to fund government spending, the economic impact will be immediate. 
  • Meanwhile, a bigger existential risk looms for the global oil industry. 

Who could be benefitted with this price war?

  • The benefits of low oil price this year have started accruing to India, where petrol and diesel rates have seen a steady decline. 
  • Chemical companies can also benefit from the drop, as can airlines that can now spend less on fuel. 
  • Likewise, a weaker rupee may be beneficial for exports which had seen a continual decline in. 
  • Petroleum products constituted 13.42% of overall outward shipments who had attributed the fall in petrol prices to the decline in petroleum product exports. 
  • At a time when worldwide manufacturing exports are on the decline globally, India stands a chance to benefit if its export pricing can get more competitive on account of a weaker rupee. 
  • The decline of manufacturing in China can also benefit Indian industries looking to fill the gaps in global supply chains. 
  • However, China’s decline cuts both ways as India imports significantly from China, its biggest trading partner, and many industries rely on Chinese imports. 
  • For an Indian economic that was already spiralling downwards, the coronavirus effect is likely to add to the woes. 

How will the oil price plunge impact Bitcoin? 

  • Bitcoin, the biggest cryptocurrency by value, fell 8%.
  • Huge moves in cryptocurrency prices are not unusual and these digital coins are known for their volatility. 
  • Market players, however, said this could be an opportunity to buy some bitcoin.
  • The digital currency is set to undergo an in-built halving, which will see rewards for miners to decrease by half. 
  • The reduction in mining rewards will reduce supply, even as demand for the coin is increasing. 
  • Because the decentralized currency cannot be tampered with, such inflation controls allow for genuine stability, unlike corporate or political confusion. 
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