Via Financial Times

Crown Prince Mohammed bin Salman was at a low ebb when President Vladimir Putin of Russia swept into a room packed with world leaders. Saudi Arabia was facing its biggest diplomatic crisis in years after the murder of Jamal Khashoggi weeks earlier, and the kingdom’s heir-apparent, who many blamed for the journalist’s killing, had faced a cool reception at the G20 gathering.

But Mr Putin smiled broadly as he high-fived Prince Mohammed and took a seat next to the beaming Saudi. The meeting in Buenos Aires in November 2018 epitomised the warming relationship between two authoritarian leaders whose nations spent decades on the opposing sides of global divides but had found common interest: maintaining the stability of oil prices.

That compact collapsed spectacularly last week as two of the world’s top energy producers became embroiled in an oil price war that wrought chaos on global markets already reeling from the coronavirus pandemic.

Caught in the maelstrom is Donald Trump, who ignored critics to stand by Prince Mohammed after the Khashoggi murder and has confounded many with his repeated praise of Mr Putin’s leadership. Just as the US president is gearing up for an election battle under the cloud of the Covid-19 outbreak, the Russian-Saudi crude war threatens America’s growing shale industry, hurts debt-burdened US oil majors and exacerbates the pressure on collapsing stock markets.

“We’re in a three-way Mexican stand-off with three big players in the room all saying, ‘if you screw that guy over there, you are screwing me over, so I’m going to screw you over,’” said Michael Stephens, an associate fellow at the Royal United Services Institute. “It’s a strange triangular discussion from which no side wants to back down and all are going to feel the pain.”

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The price war erupted when Russia rejected a plea from Saudi Arabia to make deeper cuts to oil production to stem the slide in prices as the coronavirus pandemic spread, ending three years of co-operation between the two on crude output. Riyadh, the de facto Opec leader, responded swiftly with its most aggressive oil-related action in decades, threatening to flood the market with an additional 2.6m barrels a day at hugely discounted prices. Benchmark crude prices plummeted by more than 30 per cent last week.

Moscow’s target is the US shale industry, whose output has soared by 4.5m barrels a day since Prince Mohammed and Mr Putin agreed to co-operate on production cuts in 2016, chipping away at Russian and Saudi market share.

Saudi Arabia, the world’s biggest exporter, is betting that increased volume will cushion the financial impact of tumbling prices, boost its market share and either bring Moscow back to the table or reshape the energy industry.

Line chart of Millions of barrels a day  showing Crude oil exports

“With all the global criticism and people jumping on the Khashoggi killing, I think the feeling is, ‘we are not getting credit for being the responsible [oil] player that we are’, and ultimately everybody is in this for themselves. Why should we sit and sacrifice for nothing?” said a Saudi close to the royal court. “The beauty of this is you can blame it on the Russians. You have a legitimate answer, ‘Go talk to Vladimir, he’s the one who started this’.”

The person added that it was in Saudi Arabia’s interests to “allow this thing to go on for a while to bring structural change to the industry”.

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“Get rid of weak shale players and send a message to the Tesla’s of the world and alternative energy, there’s a lot that could change the whole picture of oil,” the person said.

Yet it is likely to reinforce Prince Mohammed’s image as an impetuous leader. It is also a big gamble for the oil-dependent kingdom. The move, coupled with the impact of coronavirus, risks crashing the economy for a second time in six years, while upending the crown prince’s own plans to diversify the economy.

Russia will also endure some pain, but it boasts higher foreign reserves, a floating currency and is less dependent on oil sales. And the signals from Moscow are that it is in for the long haul. Mr Putin’s spokesman said the Russian leader had “no plans” to speak either to Prince Mohammed or to his father, King Salman.

Line chart of Crude oil production, millions of barrels a day showing The three-way battle to lead the market in oil production

“For Saudi Arabia, it believes that every country that has fought the kingdom in a serious price war has lost. But we are facing an unprecedented situation from both the rise of shale and Covid-19,” said Amy Myers Jaffe, a fellow at the Council on Foreign Relations. “Low prices won’t necessarily spur renewed demand.”

The collateral damage will ripple from Baghdad to Texas.

A decade ago, US would have clearly benefited from lower oil prices, but its rapid emergence as the world’s top oil producer has altered that calculation. States that were beneficiaries of the shale boom such as Texas, North Dakota and Pennsylvania will be victims of a price war that seeks not just to lower prices but to crash them.

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The Kremlin has long viewed Washington’s sanctions against Russia to be partly motivated by a desire to create more space for US shale. “The increase in the share of the US oil on the global market is often achieved not so much via economic as via political methods — by ousting key players and foisting products,” said Igor Sechin, Rosneft’s chief executive, in October.

While some in Saudi Arabia are emboldened by the belief that the kingdom fatally undermined the Soviet Union economy in 1986 by flooding the market, others fear the crown prince may have gone too far. “You annoy Russia and now you’re going after the only friend [Trump] you have: this is complete lunacy,” said a Gulf-based analyst. “There’s a real sense of despondency among Saudis I know. ”

Oil traders are waiting to gauge if, and how, two of the world’s strongmen can step back while saving face. “Even if the price war is resolved, chances are sour feelings will linger,” said Ms Myers Jaffe. “I don’t see a quick reconciliation.”

Additional reporting by Anjli Raval in London