Yuri Barsukov on the reasons for Saudi Arabia’s decision to reduce oil prices

Saudi Arabia’s decision to sharply cut the price of its oil for February delivery across all sales regions sent Brent prices down 4% on Monday. The point is not even that the level of contract prices was immediately lowered by $2 per barrel. A key factor spooking the market is that the world’s largest oil exporter is having trouble selling its crude as key members of the OPEC+ alliance were expected to cut production in January. In other words, while the cartel is unable to adapt to market conditions, and Saudi Arabia, having taken on the burden of voluntary production cuts, finds itself in an increasingly vulnerable position, like other countries that have decided to maintain prices through cuts, including Russia. After all, cutting production pays off only if prices rise, and during these winter months oil generally becomes cheaper, and there are no economic factors yet visible that would change this state of affairs.

Further, it would be appropriate to write that no cartel policy in the oil market is successful forever: by maintaining high prices, the cartels themselves feed their rivals and are then forced to deal with them during extremely costly price wars, as was the case in 2014–2015 and 2020 . Already, OPEC+ is suffering not only from external competition from American, Canadian and Brazilian oil, but also from internal competition between Saudi Arabia and Russia, which “voluntarily reduced”, Iran, which continues to produce in the previous paradigm, and in recent months, against the backdrop of easing sanctions, Venezuela . As hopes for a post-Covid boom in oil demand in Asia grow increasingly dim, a period of low prices – or even a price war – looks increasingly necessary to revive a market where there is more oil than needed.

However, the situation is now complicated by the fact that prices are directly affected by the risks of a very real war in the Persian Gulf region. Since the scale of the escalation is extremely difficult to predict, traders are torn between rational arguments that it is stupid to buy in such a market for more than $70 per barrel, and fears that in the event of even a short-term closure of the Strait of Hormuz, cargoes will not be available at $120 per barrel. This artificially supports oil prices without, however, affecting the scale of supply, since the production or transport infrastructure has not yet been damaged. As a result, a potentially dangerous situation is created for OPEC+ participants, in which the sudden disappearance of military risks could provoke a collapse in quotations, which, in turn, will trigger new painful disputes within the cartel about how to respond to this.