Booms, Busts and Oligopolies
The oil industry, as it emerged from the United States and spread globally in the late nineteenth and early twentieth centuries, suffered from a constant boom and bust cycle. Oil’s early history offers potent examples of such volatility. Capital formations were created to manage this volatility in order to ensure the profitability of oil and its expansion as a viable source of energy for the industrialized world.
Between 1911 and 1973, large vertically-integrated corporations dominated the international oil market. They drew on support from European imperial powers, as well as the United States, to secure commercial concessions in the Middle East. These European and American companies feared unrestricted competition over Middle East oil would produce a supply glut. They therefore cooperated for decades to restrain output, managing production to meet their supply needs. The companies formed an oligopoly—not a true monopoly, but a union intent on limiting competition and controlling supply.
The oligopoly’s control over the international oil market collapsed in the 1970s. Oil producing governments within OPEC—which was established by five countries in 1960 in Baghdad and now represents 13 members—engineered a take-over of foreign oil companies’ concessions in their countries. This wave of nationalizations was accompanied by major changes in the global order and was carried out within the context of de-colonization. Yet, since OPEC shared the oligopoly’s interest in managing competition and restricting output, it took over the role of oil’s former corporate masters and squashed hopes of an economic redistribution from the oil-consuming Global North to the commodity-producing states of the Global South.
The actions of oil states are driven by both economic and political interests. Most oil-producing states, including Saudi Arabia, Iraq and Kuwait, built economies that revolved around oil. The influential concept of the “resource curse” emerged from the study of OPEC states in the 1970s and 1980s: Oil, rather than spurring economic growth, produced dependence and imbalance, creating vulnerabilities to spikes in the international oil market. Since the 1970s, OPEC governments have been acutely aware of their dependence on oil, and equally concerned with what a collapse in prices might do to their internal political stability. These fears have encouraged them to cooperate, as the oligopoly once did, to maintain the price of oil and manage competition.
Each OPEC country has a national oil company that manages the industry and partners with international companies—such as ExxonMobil, Total, Chevron, BP and Shell—to market oil and oil products internationally. OPEC’s petrodollars are tied into the global financial system, recycled through weapons sales and real estate investments, integrated through financial mechanisms and have permeated the tech industry. After challenging the West’s dominance of the global system in the 1970s, OPEC emerged as an institution deeply entangled in the globalized economy.
Yet in 1985, Riyadh changed its strategy. The swing producer chose to pump at will, increasing production from five million barrels per day to ten million, in order to seize market share and impose discipline on other producers. Prices crashed, American companies were put out of business and the Soviet Union experienced an intense financial crisis that contributed to its collapse five years later. Riyadh demonstrated its economic power in order to bring other OPEC states into line. The episode also illustrated the dangers of a “free” oil market—or at the very least, a market unregulated, open to competition and bereft of a monopolistic influence to guide it.
This Too Shale Pass
In the early 2000s, the world was in the grip of so-called peak oil fever. Oil prices exceeded $100 per barrel. The sense of impending scarcity fueled violence. The US invasion of Iraq and the global war on terror seemed closely linked to the steady rise of oil prices. Dozens of books from across the political spectrum were published, warning of a world with declining access to energy—a world of perpetual high prices, diminished standards of living and wars fought to control the dwindling petroleum reserves.
Spurred by worries over permanent dependence on imported oil, the George W. Bush and Barack Obama administrations encouraged research and development into alternative methods for extracting oil and gas. High prices made such measures more commercially viable. For these reasons, American oil companies began experimenting with hydraulic fracturing, an obscure and costly method for breaking apart “tight oil” locked in rock formations deep beneath the earth’s surface. The result was dubbed the shale revolution. American domestic oil production doubled—from five million barrels per day to ten million per day between 2009 and 2019.
The conversation around oil shifted. The term peak oil vanished from the discourse, replaced now with “drill, baby drill” and concerns around what is called peak demand. The 2008 financial crisis and the end of the global commodities boom in 2011, combined with slowing Chinese economic growth and rising fears of the effects of global climate change, produced concerns among analysts that oil’s future would be dominated by competition over a dwindling market awash in a perpetual glut.
In 2014, the energy minister for Saudi Arabia was Ali al-Naimi. His response to the rise of shale was to boost production, filling the market with cheap crude oil. Oil prices fell to their lowest level in decades, from $100 per barrel in early 2014 to $30 per barrel in January 2016, pushed down by Saudi Arabia’s over-production. While Saudi Arabia’s large cash reserves absorbed the impact, other oil producers were not so lucky. Venezuela fell into political, social and economic chaos and the grip of US sanctions. Algeria possessed large cash reserves, but these were exhausted by late 2019, prompting a spike in protests that continued into 2020. Al-Naimi’s policy damaged nearly every OPEC member.
The strategy was a clear failure. American companies stayed in business by cutting costs and taking on more debt. After the price of oil fell to $30 per barrel in 2016, driven low by Saudi production, US output fell only 17 percent. Though the number of American wells fell from 21,500 in 2014 to 6,500 in 2016, production per well increased as drillers worked more efficiently.
In 2016, Crown Prince Mohammed bin Salman removed Al-Naimi as energy minister. As the de facto head of the Saudi government, bin Salman used the energy crisis to push through a new strategy. A raft of new economic policies, known as Vision 2030, were proposed to reduce the Saudi state’s dependence on oil production. In the meantime, to stabilize prices, Saudi Arabia led the rest of OPEC in cutting production, removing over 1 million barrels per day from the global market. The crown prince succeeded in bringing along Russia, a non-OPEC state and a major oil exporter, to join in the cuts. Rather than compete, OPEC and Russia (colloquially referred to as “OPEC+”) colluded to reduce output, boost prices and retain oil’s value.
The temporary OEPC+ production cuts lasted for more than three years. While Saudi Arabia withheld production, the shale revolution picked up momentum again. Though prices remained comparatively low, American companies benefited from cheap credit, encouragement from President Donald Trump’s administration through relaxed regulations and an apparent disregard for short-term profitability. In 2019, the United States’ output exceeded 10 million barrels per day and the nation became a net exporter of oil and gas for the first time since 1948.
Then came coronavirus. In early 2020, as it struggled to contain the spread of the COVID-19 disease, China announced dramatic cuts to its oil demand forecast. As the world’s single largest oil importer, China’s announcement sent shockwaves through the oil world. Saudi Arabia gathered support for a new cut to production in the run-up to the annual OPEC meeting on March 5 in Vienna. Riyadh wanted to take 1.5 million barrels per day off the market in order to support prices in the face of falling demand. The rest of OPEC reportedly supported the Saudi policy.
What happened next took everyone by surprise. Russia refused to consider the Saudi proposals, and after hours of discussion the conference ended without an agreement. Shortly thereafter, Russia announced that it would increase—rather than cut—its oil production. Russian motives are opaque. Russian oil officials were frustrated with losing market share to US shale, and believed that ending production cuts would allow Russia to regain its market position at a time of falling demand. It is also possible that Russia’s relations with Saudi Arabia, frayed by the war in Syria, had deteriorated to the point that the oil alliance was no longer tenable.
In any event, the Russian decision prompted Saudi Arabia to assume an even bolder strategy. Immediately after the March 5 OPEC meeting, Crown Prince bin Salman ordered the Saudi oil industry to maximize production and exports in April. From 9.7 million barrels per day, Saudi Arabia has the capability to increase production by as much as 2.5 million barrels per day, a 2 percent increase in the world’s total oil supply. The Saudi intention is to flood the market, offering huge amounts of oil at rock-bottom prices. The target of this price war is Russia. As in the 1980s, Saudi Arabia is using its spare capacity to bring order to the producers’ cartel in order to balance prices in the long run. It is also apparent that the US shale oil industry will suffer the worst of the damage.
Yet, at the same time, Saudi Arabia is responding to the threat of falling oil demand. Even before COVID-19 appeared, there were concerns that peak demand would sap oil of its value. Without sufficient investment derived from higher prices, billions of barrels would have to remain in the ground. Mohammed bin Salman is making a gambit—he is hoping that cheap oil will appeal to consumers, encourage continued demand for Saudi crude and potentially push more expensive producers out of the way. Fear of an uncertain future drives the Saudi policy. The broader impacts of the price war will be felt throughout the world.
After the Saudi announcement to increase production, the oil market crashed. On March 9, prices dropped more than 30 percent to just above $30 per barrel. There has been no recovery—in fact, prices slid into the $20 per barrel range by March 19. For consumers in the United States, this means low gas prices—a potential benefit that Trump was quick to point out. But with oil prices falling to their lowest levels in decades, the over-leveraged and debt-burdened companies on the shale patch will be squeezed to the breaking point.
The decision to abandon cuts and maximize production is a risky move for bin Salman, who faces growing dissent at home, a costly war abroad in Yemen, and an economy ill-suited to manage another period of sustained low prices. Russia’s economy, while dependent on oil and gas, may be partially preserved thanks to the nation’s large cash reserves. While bin Salman faces new challenges at home, Russian President Vladimir Putin is now de-facto president for life. Russia will feel the pain from this price shock, but it is unlikely to shift Putin from his position atop the country’s power structure.
OPEC states will feel the brunt of this price collapse. Iraq and Iran will certainly be affected, though the latter’s oil exports have dropped to nearly nothing due to international sanctions, and the issue will likely be overshadowed by the rapid spread of coronavirus. Gulf states, such as Kuwait, the United Arab Emirates and Qatar (which formally left OPEC in 2014), will suffer economic shocks, though their cash reserves and small populations insulate them somewhat. Other states which have endured prolonged crises from the 2014–2015 shock, including Libya and Venezuela, will suffer even more, the former from a protracted civil war and the latter from US sanctions that impede oil exports. Protests in Algeria, a large country that requires high prices to sustain its economy, are likely to continue, once the effects of COVID-19 wear off. Major state-owned oil companies, from Mexico’s PEMEX to Brazil’s Petrobras and Saudi Aramco, have piled up heavy debt loads and could see contractions from a prolonged period of low prices.
No one will win this price war, as it comes amidst a global economic crisis stemming from the coronavirus outbreak. The OPEC failure in Vienna will have a sweeping impact on global energy. Fear of falling demand has pushed Saudi Arabia to make a bold gambit. But it may backfire. By demonstrating the continued volatility of fossil fuels, and the relative failure of existing monopoly-like power structures to contain such volatility, this price war may encourage investors, consumers and governments to embrace alternative sources of energy. The collapse of cooperation and the surrender to an unregulated oil market could have profound effects on the continued resilience of the fossil fuel economy. Far from preserving the value of oil, this latest Saudi maneuver may signal the end of oil’s dominance and the beginning of an entirely new energy paradigm.
[Front page photo: An oil tanker is loaded at Saudi Aramco’s Ras Tanura oil refinery and oil terminal, 2018. Ahmed Jadallah/Reuters]