Strategy Note /

Oil war: Saudi, Russia can sustain a long war, but a 35% price drop shortens it

  • Both Saudi and Russia have the financial capacity to sustain this war.

  • They also have sufficiently divergent aims for the war to persist.

  • But the collapse in oil price may shorten the length of this war.

Oil war: Saudi, Russia can sustain a long war, but a 35% price drop shortens it
Hasnain Malik
Hasnain Malik

Strategy & Head of Equity Research

Tellimer Research
9 March 2020
Published byTellimer Research

How long the oil war lasts, following the breakdown of Saudi and Russia cooperation on oil output via OPEC+, depends, like most wars, on: (1) how much pain each side can absorb; and (2) what the goal is for each side. 

Both sides have enough financial capacity and sufficiently divergent goals to sustain the oil price war for some time (quarters, rather than months).

But such a sharp drop in the oil price (down over 35% in a week) may actually shorten the length of this war. 

The sense of trauma for oil exporters (e.g. Saudi and the GCC, Russia, Colombia, Kazakhstan, Nigeria) and hope for relief for importers (e.g. China, India, most of south and south-east Asia, Kenya and Egypt) may prove more fleeting than many assume.

Non-symmetric goals in the oil war

But the goals of each side are not symmetrical. Saudi's aim appears relatively straightforward: bring Russia back into a collusive arrangement on output restraint. 

However, Russia's aim is not so clear: 

(1) Simply maximising its own oil volume and revenue (perhaps not anticipating the severity of Saudi output expansion and subsequent collapse of oil price would have on every oil exporters' revenues, including those of Russia),

(2) Establish its role as the effective swing negotiator of oil price (even if Saudi retains the role of swing producer in physical capacity terms), 

(3) Inflict distress on US shale (which may be a large enough driver of the investment portion of US GDP to offset the benefit of higher consumer spending and may be a large enough portion of the high yield credit market to create a systematic effect), 

(4) Gaining Saudi (and wider GCC) cooperation on geopolitical matters spanning Libya-Syria-Iraq-Iran and on arms purchases.

Financial capacity for an oil war

Saudi fiscal break-even oil price is about US$80, double that of Russia. This suggests Saudi is in a weaker position. And, arguably, Saudi domestic political sensitivity to economic stress is much higher than that of Russia (because of the importance of public project spending and welfare provision).

But with foreign reserves of over US$500bn and further debt-raising capacity, with debt to GDP of merely c25%, this war can be fought for quite some time. 

Saudi could opt to finance a larger fiscal deficit with more debt issuance, particularly in such a low interest rate environment, but with such large reserves it is not essential.

The fallout in EM and FM from the oil war – for exporters and importers