This will have big repercussions for U.S. energy producers, which face lower prices and a potential loss of customers, as Saudi Arabia seeks sales volumes at the expense of Russian and U.S. producers. The consequences for geopolitics, however, are even more important.
Since 2016, the Organization of the Petroleum Exporting Countries has worked with Russia and a few other countries to try to boost prices in the global oil market. This group goes by the name OPEC+, but real power lies with just two of its members: Saudi Arabia and Russia, the biggest exporters in the world.
Up until this month, OPEC+ claimed it maintained “cuts” of about 2.1 million barrels per day. In theory, the group boosted prices by restricting supply, but it was never clear how big the cuts actually were. When Saudi Arabia asked Russia this month to cut oil production even further, Russia refused and announced it would no longer respect any restraints. In response, Saudi Arabia said it would expand its oil production to more than 10 million barrels per day, seeking increased market share.
What caused the Saudi-Russia split?
Russia’s reaction should not have been surprising. Russia’s exports make up less than 10 percent of world consumption, which is why it tries to collaborate with OPEC, which collectively produces about 40 percent of world oil.
Yet running an oil cartel is hard, because no member really wants to cut its own oil production — and lose sales — to boost the overall price. Members promise to contribute to collective cuts, but neither OPEC nor OPEC+ has real power to make sure its members keep their promises. My research shows that OPEC cheats on its agreements about 96 percent of the time.
In reality, Russia’s “cuts” under OPEC+ probably did not reduce its production by much. So when Saudi Arabia pushed for cuts that might be more painful, Russia decided it didn’t make economic sense.
Now, Russia may think that its best way forward is to maintain high levels of production and hope its American competitors go bankrupt, leading to higher prices. Russia’s current oil wells probably run an operational profit even at relatively low prices, even if they don’t cover the full capital costs of drilling the well.
If Russia and the rest of OPEC aren’t helping, Saudi Arabia doesn’t have much incentive to restrict its own production. It learned this the hard way in the early 1980s. Prices fell dramatically, even though Saudi Arabia cut 70 percent of its production, losing a lot of market share. The Saudis are determined not to make the same mistake again.
On the one hand, low prices might hurt the U.S. economy
Lower oil prices are a mixed blessing for the United States. Lower gasoline prices will benefit consumers and lower transportation costs for businesses. However, they are very bad for U.S. oil producers. Highly indebted fracking firms may not be able to obtain further bank loans or perhaps even stay in business. States such as Texas and North Dakota, where fossil fuel extraction is a big part of the economy, would face hard times.
The pain could spread to the entire U.S. economy. If low prices continue for months or years, there will probably be bankruptcies and mergers in the oil sector, perhaps lowering gross domestic product or exacerbating the stock market decline on Wall Street.
On the other, they may help peace efforts in the Middle East
Saudi Arabia is fighting a war in Yemen. Russia is intervening in Syria. Both use oil money to finance their war machines. As my research shows, oil wealth can make states with aggressive intentions more likely to act on those intentions. That kind of “petro-aggression” leads those states into 3½ times as many military conflicts as typical countries.
Political scientist Cullen Hendrix finds evidence that lower oil prices actually lead to less interstate conflict. Wars depend on many other things than oil prices, of course. Still, a prolonged period of low oil revenue might cause even a very rich country like Saudi Arabia to rethink its incursion into Yemen.
Cheap oil has mixed consequences for climate change
Lower oil prices are also a double-edged sword for climate change. In the United States, they could deprive oil firms of spare resources to pour into lobbying efforts against legislation on climate change. My research with Jessica Green and Thomas Hale suggests that kind of political obstruction is instrumental in preventing green initiatives.
Globally, however, low oil prices might make it harder for electric and hybrid vehicles to compete with conventional cars, slowing efforts to reduce greenhouse gas emissions.
The U.S.-Saudi relationship could sour
Saudi Arabia’s decision was a clear jab at Russia, as it seeks to seize market share, but it also hurts U.S. producers. In the past, U.S. governments have put pressure on the Saudis not to do such things. This time around, the Saudis seem unconcerned about the White House reaction. That is understandable, given President Trump’s unconditional support of the Saudis to date, on issues ranging from the Yemen war to the killing of journalist Jamal Khashoggi.
Still, low oil prices might push Trump to think again. His claim that the United States enjoys “energy dominance” is looking increasingly hollow. If low oil prices start an avalanche on the stock market, even Republican supporters in the oil sector will want some answers about Saudi actions. Trump might yet turn on Saudi Arabia.
Jeff Colgan is the Richard Holbrooke Associate Professor at Brown University. He tweets at @JeffDColgan.