Oil price war: Is it game of chicken or battle of nerves?

March 6, 2020 is a milestone in the oil industry when two giants in the field locked horns for supremacy in oil price war. When Saudi Arabia requested reduction of oil production by 1.5 million barrels a day Russia vetoed it and declared that she will not conform to existing voluntary production cuts. Immediately KSA announced that it will increase output. Consequently, price plummeted by 25%. The business warfare on oil began.

Business strategists are wondering whether this leads to a game of chicken or battle of nerves. For the uninitiated, the game of chicken implies a contest between two players where neither one wants to back down nor let the other win even though not backing down is suicidal. On the other hand, battle of nerves is a situation where neither side in a conflict is willing to back down but expects the other to weaken.

Russia has amassed a war chest of US$ 570 Billion in cash and mainly in gold and can withstand low price oil regime @ US@ 25 per barrel for a period of 10 years. Cost of production of oil is around US$ 15 per barrel. Russia earns in US$ and spends in Ruble. Depreciation of Ruble will make its exports cheaper. Moreover it frees the economy to invest and enlarge non-oil sector. Russia adopts flexible fiscal policy that can be adjusted to support oil producers to cushion adverse effects. For Russia balancing her budget with huge development program requires oil price in the region of US$ 30 per barrel.

KSA has also has a surplus of US$ 450 Billion mainly in cash and US Treasury bonds. It cannot sustain low price regime for more than one year because it already runs a huge budget deficit. Never the less KSA has ability to borrow from market sources or liquidate US Treasury bonds. KSA has few more pluses: It can produce in certain wells oil as low as US$ 1 per barrel. None the less exhaustion rate dries down the spare capacity to a decade or so. She has invested heavily on Vision 2030 requiring massive investments into non-oil sector.  There is a double whammy in that balancing fiscal budget needs oil to be sold @ US$ 80 per barrel.

This oil war neither fits into game of chicken nor battle of nerves because considering the above strengths and weaknesses it is wise business strategy to fix a time frame for the duration of oil price war. Both Putin of Russia and Mohamed bin Salman (MbS) of KSA are pragmatists and are guided by common business sense and must begin consultation via back door channels for a win-win solution.  

 

Cheers!

 

Muthu Ashraff Rajulu

Business Strategist

Mobile: + 94 777 265677

E-mail:   cosmicgems@gmail.com

Blog:   Business Strategist