Saudis gambling on game of oil-price chicken

The demand for oil is falling. The supply of oil is increasing. The result – as even those with only the scantiest understanding of economics knows – is that the price of oil must be falling.

And some. The cost of Brent crude – one of the market benchmarks – fell to below $23 a barrel in early trading, the lowest it has been since the US and the UK were making preparations for the invasion of Iraq in November 2002.

The fall in demand is easy enough to explain. Planes have been grounded and factories mothballed as a result of the Covid-19 pandemic. People are working from home and so using their cars less. Developed economies have become more service-sector dominated than they were 40 years ago but they still consume a lot of crude. And if an economy shrinks by 15% or 20% in a single quarter – which looks eminently plausible for the US and Western Europe – then it is going to need a lot less oil. It is as simple as that.

Oil rig closures rising as prices hit 18-year lows

What’s happening to supply requires a bit more of an explanation, because with demand collapsing the normal response of the big producers would be to limit output in the hope that would stabilise the price.

This time it is different. Saudi Arabia has responded by turning the taps full on even though its own government finances will suffer from a lower oil price. Why? Because the Saudis are in a power struggle with the world’s other two major producers – the US and Russia – and is convinced it can endure the pain of a low oil price for longer than they can.

In this global game of chicken, Riyadh is gambling that it can eliminate competition from the US shale oil sector – much of which is unviable at $20 barrel – and force Moscow into accepting the need to get serious about production curbs. The Saudis ramped up the pressure at the weekend by making it clear that they were not close to a deal with the Russians.

That announcement was the trigger for the latest price fall, and all the signs are that the cost of crude will go still lower. With Donald Trump accepting the need to keep tough Covid-19 restrictions in place until the end of April, it is clear that the crisis is going to last for longer than originally expected. It won’t be long before storage capacity runs out.

The current weakness of oil prices will not last for ever. Supply will go down as a result of US shale producers going out of business and an eventual deal between Riyadh and Moscow. Demand will go up, in part stimulated by falling oil prices, which lower business costs and boost consumer spending power.

But for the tide to turn one of two things need to happen. The Saudis need to stop flooding the market and consumers need to be able to spend their windfalls. Neither looks imminent.

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