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Oil Price War: It Takes Three to Tango

Dr. Gawdat Bahgat, NESA Center

In the last several weeks, people all over the world have understandably been occupied by the Covid-19 outbreak. The virus has spread globally and has already infected more than a million people. In addition to worrying about their own health, people are worried about their well-being, employment status, and prospects for economic recovery in the post-Coronavirus era. In the first week of April, one barrel of oil was sold for about $20, too low for many producers to stay in business. Like other economic commodities, the price of oil reflects the balance between supply and demand.

Covid-19 has dealt a heavy blow to demand for petroleum. Almost 90 percent of the world’s population is under a “stay-at-home order”: meaning they should not be travelling, commuting for work, or out and about shopping for anything other than absolute necessities. Traditionally, more petroleum is consumed by the transportation sector than all other economic activities. Right now, there is not an exact estimate as to when the virus will be contained and normal day-to-day life can return. This might take weeks or months. In short, the demand for oil is certain to be very low for some time. The supply side, on the other hand, has always reflected an un-easy balance between two opposing strategies – maximum profit and market share. In other words, oil producers and exporters seek the highest price for their product. But, too high a price forces consumers to switch to other sources of energy (i.e. renewables or nuclear) and to consume less oil (i.e. energy efficiency). In the last few years, Russia had been working with the Organization of Petroleum Exporting Countries (OPEC) to maintain a balance between supply and demand. The two sides managed to cut production in order to meet declining demand. Their diminishing share of global production, however, has been filled by an emerging major oil producer – the United States.

For many years, the United States was the world’s largest oil consumer and importer. In the 1970s, the global oil market suffered from two significant “oil shocks”. The first one was in 1973-74, following the Arab-Israeli war, and the second one was in 1979, following the Iranian Revolution and the beginning of Iran-Iraq war (1980-88). These two events led to extreme fluctuation in oil prices. Against this background, American oil companies started investing in efforts to develop new technology to explore and produce oil in the United States and reduce the nation’s dependency on imported oil. It took a few decades for the outcome of these investments to materialize. This new technology is known colloquially as fracking. Since the early 2000s, United States oil and natural gas production has substantially increased as these technologies matured. The United States has emerged as an exporter of natural gas and crude imports have been cut by more than 50%. Indeed, in the last few years, the U.S. has been exporting petroleum products. In 2019, U.S. production reached 13 million barrels per day, the highest ever in the nation’s history.

Both Russia and OPEC (led by Saudi Arabia) want the United States to cut its oil production. However, unlike the rest of the world, the United States has never had a national oil company. This means the United States government cannot “force” private companies to cut production. Instead, President Trump has called on Russia and Saudi Arabia to cut their production. Traditionally, the US had always lobbied oil producers to increase production in order to lower prices. But times have changed. Regardless of these delicate ongoing negotiations between the three nations, oil prices are likely to remain low for some time. When Covid-19 is contained and economic activities are resumed, the demand for oil will grow and prices will rise.  What the long-term impact will be for the United States petroleum industry and the relationships among petroleum exporting states will remain an open question.

The views presented in this article are those of the speaker or author and do not necessarily represent the views of DoD or its components.

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