Via CNBC

Russian President Vladimir Putin (L) shakes hands with Deputy Crown Prince and Defence Minister of Saudi Arabia Mohammad bin Salman Al Saud (R) during their meeting at the Kremlin, on May 30, 2017 n Moscow, Russia. Saudi Arabia’s Crown Prince is on the visit to Russia.

Mikhail Svetlov | Getty Images

The clash between Russia and Saudi Arabia over an oil price strategy appears to pit the two nations against each other in a vicious battle for market share, but analysts say they are really at war with the U.S. oil industry.

Intentional or not, the open price war has sucker punched the U.S. oil industry with a massive decline in oil prices since Friday. The downturn could damage the U.S. economy, result in a smaller American energy industry, and knock the U.S. from its position as the world’s largest oil producer, analysts say.

Tensions between Saudi Arabia and Russia have been rising since Russia failed to agree to deepen an existing  production cut of 1.8 million barrels a day in response to a sharp decline in demand. The drop in demand was caused by the fall-off in travel worldwide, and the quarantine of millions of people due to the coronavirus.

The rift between Saudi Arabia and Russia appeared to have widened more Friday after OPEC and Russia ended their meeting with a break in the more than three-year-old agreement on production cooperation between OPEC and non-OPEC producers. Saudi Arabia immediately responded by offering steep price discounts and announced a production boost, actions that helped trigger the steep price decline. Russia claimed its oil industry will maintain its market share and can weather a price downturn.

“While OPEC leadership retains hope that the price collapse will be a catalyst for a reconciliation between the two oil heavyweights, President Putin may not quickly capitulate,” writes Helima Croft, head of global commodities strategy at RBC. “We fear that it could be a [protracted] struggle, as Russia’s strategy seems to be targeting not simply US shale companies— but the coercive sanctions policy that American energy abundance has enabled.”

She noted that Russian President Vladimir Putin may have been influenced by Igor Sechin, chairman of Russia’s biggest oil company Rosneft. Sechin has long opposed the OPEC production deal and was angered by U.S. sanctions on Rosneft’s trading.

Russia was also angered by U.S. sanctions stalling its efforts to complete its Nord Stream 2 pipeline, which would take natural gas to Europe.

“There is no question this was a huge humiliation for the Russians to have the Nord Stream 2 pipeline construction stopped just short of completion,” said Daniel Yergin, vice chairman of IHS Markit. The U.S. has opposed the pipeline since it would increase Russia’s dominance of the European energy market.

The Trump administration has not shied away from the fact that more U.S. energy production has meant less reliance on foreign sources, and a greater ability to impose sanctions on energy producers, like it has on Iran and Venezuela.

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“For now, it seems that Sechin is not seeking to eliminate simply the market share of US shale producers, but the aggressive US sanctions policy that American energy abundance has enabled,” wrote Croft. “Trump administration officials have repeatedly bragged about the ability of the US to punish its foreign policy adversaries by sharply reducing their oil exports, and to be shielded from the price impact because of abundant domestic energy supplies.”

Croft notes that Sechin, like Putin, comes from a background in Russian intelligence services and is viewed as a strong nationalist. “Undercutting American energy dominance therefore most likely appeals not only to his bottom line but also to his ideological [affinity],” she wrote.

The U.S. Department of Energy said late Monday that the U.S. will remain the world’s number one energy producer because of pro-growth policies. “These attempts by state actors to manipulate and shock oil markets reinforce the importance of the role of the United States as a reliable energy supplier to partners and allies around the world. The United States, as the world’s largest producer of oil and gas, can and will withstand this volatility,” the DOE said in a statement.

Price war 

A global market share war could result in another 10% or more decline in prices, analysts say. That could be a huge body blow to the U.S. oil sector, with companies that are cash-strapped facing sharper cutbacks and even bankruptcies and forced mergers. Investor distrust of the industry for overspending has resulted in a lack of funds for the sector and capital expenditures are likely to become even more limited.

“The market expected the Saudis to act as they always do, which is to basically curtail production to balance the market, but they went out and did the exact opposite,” said Francisco Blanch, head of global commodities and derivatives at BofA Securities. “They could have just stayed where they were and then the question is, is this something the Saudis are doing because they wanted to teach the Russians a lesson and bring them into the fold, or is this alternatively something the Saudis are doing because they believe the Russian theme in this is the right way to deal with the virus? The question is are Russia and Saudi joining forces to hurt U.S. shale or are they fighting against each other.”

Blanch said he is unsure what is behind the rift, but the motive will likely become important as markets move into the second half of the year. If the squabble is only between Saudi and Russia on strategy, it could be shorter lived and a new deal could be worked out by Saudi-led OPEC.

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“The real political fact is that the U.S. is a lot less involved in the Middle East than it used to be, and that Russia has deepened its presence in the region pretty dramatically in recent years, and this is both political and economic. So, Russia, in other words, carries more weight than it used to. Its influence is being felt alto more than in the past,” Blanch said.

Yergin said it appears Russia’s motives could be driven by its desire to hit U.S. shale, which has been a wild card in the world market over the last decade. The U.S. industry responds purely to economics and financial conditions, while other major producers are impacted more directly by their governments.

“It’s Saudi Arabia against Russia and Russia against the United States. I think that’s what it is. The Russians can’t increase production much and the Saudis can,” Yergin said.

John Kilduff of Again Capital said Russia may have taken Saudi Arabia’s commitment to steady the oil market for granted. “They may have gone a step too far and the Saudis basically said: ‘This is what pump-whatever-you-want looks like,'” said Kilduff. He said Russian energy minister Alexander Novak said Friday that all producers would have the right to pump whatever they wanted as of April 1.  

Yergin said Russia likely sees a sharper decline in demand and wants to act now. “The first quarter estimate is that the global oil market is 3.9 million barrels a day lower than it was in the first quarter of last year. The overarching issue here is what to do in a market that is contracting on a very large scale as the global economy freezes up,” he said.

Blanch expects Brent crude, which touched a low of near $31 per barrel, could fall to the low $20s per barrel before steadying. Brent was already well off the high of $75.60 it reached in April, 2019.

Croft, who was in Riyadh on the weekend, said it’s clear Saudi Arabia intends to pump aggressively, flooding an already oversupplied market. “During our 36 hours in Riyadh, it was made clear to us that the central banker of oil was preparing for a swift and substantial production increase that could retest the 2018 highs of just over 11mb/d,” she wrote.

“Despite the huge fiscal costs that such a policy entails, Saudi Arabia seems determined to keep the spigot open until Russia agrees to rejoin the 23 other OPEC+ producers and participate in a massive collective production cut (which could balloon out to even 2 mb/d) to try to address the demand impact of Coronavirus,” she added.

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This year’s wobble in oil prices has been hitting U.S. oil companies, which already have been under pressure from a  limited access to capital markets. But even so, that has not stopped U.S. oil production from holding at a near record 13.1 million barrels a day last week and U.S. exports reaching a record 4.15 million barrels a day.

As Saudi is poised to add oil to the market, analysts expect demand to continue to decline, resulting in the first contraction since the financial crisis. Chinese demand has already dropped by about 20% in the last several months, and with quarantines already in Italy and a slowdown in travel, demand is also falling in Europe and the U.S.

In the U.S. the economies of oil producing states, like Texas and North Dakota are expected to be hardest hit by an energy slowdown.

“This whole energy industry picture is going to be abruptly driving in reverse,” said Yergin. “The supply chains of the oil and gas reach deeply across the industrial Midwest so this hits the steelworker, this hurts the people who build machines in the U.S. so it’s not just a crisis in the oil patch. … U.S. oil production is going to go down and that would be bad for the trade balance. …The U.S. is number one now in both oil and gas, but at these price levels that’s not going to last very long.”

Blanch said he expects a bounce back after a steep decline in oil prices, and while it will have a negative impact on the U.S. economy, consumers should benefit from cheaper fuel prices.

The break in the oil deal comes, even as Saudi Arabia and Russia continued just weeks ago to signal a chumminess in relations through investment deals between Saudi Arabia and Russia. President Vladimir Putin and Saudi Crown Prince Mohamed bin Salman have moved closer together over the past several years with the oil deal a common bond.

MBS, as the prince is known, has also been viewed as having close ties to Washington, with a seeming congenial relationship between the prince and President Donald Trump. Saudi Arabia has also won favor in Washington with deals for U.S. military equipment, as well as the young prince’s vision for a diversified Saudi economy, away from oil.

Over the weekend, senior royal family members, seen as rivals to MBS, were detained. The three senior princes including Prince Ahmed bin Abdulaziz, the younger brother of King Salman, and Prince Mohammed bin Nayef, the king’s nephew, for allegedly planning a coup, sources with knowledge of the matter said.

“That’s another sign of pressure on MBS to come through with his grandiose plans for the kingdom, or at this point just hold the economy together,” said Kilduff.