Oil price war: Saudi Arabia’s pyrrhic victory

 

Erwin Rommel, the German field marshal who overran France in one month during World War Two, once said that a sensible man does not start a war that he would gain nothing by winning. The tacticians in Saudi Arabia’s oil price war room have no respect for that battlefield refrain.

The Saudis would start a price war they know they cannot win.  They kicked up a stupid price war in 2016 when a glut in the international oil market pushed prices below $70 per barrel.

Rather than cutting supplies to reverse tumbling prices, the Saudis decided to fight a glut-induced price fall with a glut. They pumped oil into the market with the hope that high production cost would force shale oil producers to shut down their rigs when oil prices drop below $50 per barrel.

However, the number of shale oil rigs that were shut down was too insignificant to reduce supply and push up prices. The Saudis changed their strategy and persuaded Russia to join in cutting supplies to boost prices.  The Russians obliged and oil prices started inching up.

It was a rescue that came rather late. The tactical blunder of the Saudi oil price war had ruined the economy of Venezuela before the belated tactical withdrawal. Venezuela’s economy collapsed as a result of the stupid price war strategy adopted by the Saudis. Today, more than two million Venezuelans have fled their country in search of food and shelter.  Venezuela’s bolivar now trades at 300, 000 to the dollar.

The same blunder pushed Nigeria’s economy into recession for about five consecutive quarters.  Nigeria’s economy did not collapse because, unlike Venezuelans, Nigerians do not depend on their government for their basic needs.

On Monday, March 9, 2020, the Saudi oil price war tacticians replayed the same scenario that brought economic calamity to many oil dependent countries in 2016. The Saudis had persuaded the cruel rulers of Russia to cut oil supplies by 500, 000 barrels per day in a desperate bid to reverse tumbling oil prices.

The Russians were reluctant even when the Organisation of Petroleum Exporting Countries (OPEC) offered to reduce oil supplies by one million barrels per day. The Saudis angrily called Russia’s bluff by flooding the market oil. Besides, they offered their big customers like South Korea and other Asian buyers intimidating price cuts ranging from $6 per barrel.

That single act pushed oil price from $46 to $30 per barrel and set the economy of many oil dependent countries teetering on the brink.

This time even the Saudis would pay the price of their tactical blunder. Even as Saudi Arabia has a deep pocket in terms of foreign reserves, its economy is struggling on the doldrums. It only managed to grow at a crippling 0.3 per cent in 2019. This year, collapsing oil price would take more tolls on Saudi economic growth.

The Saudis plan to create six million jobs over a period of 10 years and beef up religious tourism to 30 million pilgrims per annum. Saudi Arabia currently earns $8billion annually from the 10 million pilgrims visiting the country yearly. If the tactical blunder in its oil price war keeps prices low for months, the chances of developing facilities to accommodate 30 million pilgrims and triple forex earnings by 2030 could be hampered.

The Saudis have taken on a wrong target in their current oil price war. Saudi Arabia needs oil price at $85.7 per barrel for it to break even. Conversely, Russia, the target of the price war, can break even with oil price at $42 per barrel. The Saudis would definitely gain nothing from the price war they started in March 9 even if they win it.

Besides, the tactical blunder of the price war in 2016 has reinforced the resilience of shale oil producers. New technology has reduced their cost of production. Shale oil producers can now remain in business even when oil prices drop to $30 per barrel.

That tactical blunder would this time worsen the economic plight of Iran and Iraq, two major oil producers battling crippling economic crisis. Iran’s economy is writhing under the pains of American sanctions and the tumbling oil price could trigger fresh street protests that could dwarf the one in the first half of 2019. The economy of Iraq is in ruins from decades of war. The tumbling oil price would worsen the situation.

Venezuela is already on the ground. It cannot descend any lower. This time Nigeria may be the major casualty of the Saudi tactical blunder. No one knows how to balance Nigeria’s 2020 budget at a time when oil price is $22 below the budget’s oil reference price of $57. When Saudi Arabia is ready to do the needful, even the budget’s oil production target of 2.18 million barrels per day would be in jeopardy.

Nigeria’s capital market is the first casualty of the brewing cash crunch engendered by tumbling oil prices. Foreign portfolio investors are fleeing the Nigerian Stock Exchange (NSE) in droves. Since the outbreak of the pandemic in January, the NSE has lost almost N3 trillion in market capitalisation.

On Tuesday, March 10,  NSE market capitalization plunged by a record N656 billion as foreign portfolio investors scrambled to cut their losses by getting out of Nigeria before the exchange rate of the naira plunges to N500 to the dollar.

Two days later, the frenzy in the capital market was transferred to the foreign exchange market when panicky foreign portfolio investors stormed the market with proceeds of their divestment from the NSE and were willing to buy a dollar at N420 just to get out.

The Central Bank of Nigeria (CBN) responded to the turmoil with assurance that it has no plans to devalue the naira as widely speculated. However, with Nigeria’s foreign reserves plummeting to a new low of $36.1 billion, foreign investors believe that the CBN can no longer defend the naira at N360 to the dollar. An economic tsunami is brewing.

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