Moscow refused to reduce oil production, prompting a response from Saudi Arabia, but the two sides could share a goal.

In the past three years, two factors have greatly affected the oil market. The first is the increase in US shale oil production, turning the country from a major oil importer into an increasingly important oil exporter. The second is an alliance between Saudi Arabia and Russia, which have cooperated to reduce oil production, to counteract the impact from the "proliferation" of shale oil.

However, the cooperation between Saudi Arabia and Russia seems to have ended. Saudi Arabia, a powerful member of the Organization of the Petroleum Exporting Countries (OPEC), last week proposed a production cut, amid global demand slumped due to Covid-19. However, Russia, not an OPEC member, has declined. The deadlock turned into an oil price war.

After talks with OPEC members in Vienna, Russian Energy Minister Alexander Novak returned to Moscow to consult with his leaders on March 5. In his absence, OPEC officials met and agreed to cut production by 1.5 million barrels a day, or about 1.5% of the world's supply. Accordingly, OPEC will cut about one million barrels while Russia and other manufacturers cut the rest.

However, the Russian minister flatly rejected the proposal. OPEC + (OPEC and its non-institutional allies) also failed to agree on continued production cuts of 2.1 million barrels a day - the contract will expire at the end of March. This creates the risk of a huge flow of oil into the already-overcapacity market when demand drops sharply as Covid-19 is affecting global energy demand.

After Russia refused to cooperate, Saudi Arabia decided to counterattack, informing customers on 7/3 that it will reduce prices deeply in April. Other regional producers such as Kuwait and the United Arab Emirates United (UAE) can follow Saudi Arabia. Saudi officials say their goal is to boost demand to gain market share.

The market quickly responded to this volatility. Crude oil price on 9/3 fell more than 30%, the strongest since 1991. Both Brent and WTI have reached the bottom of 4 years and traded around 30 USD per barrel. The contraction rate shrank to 18% in the afternoon.

Rift in Saudi Arabia and Russia alliance may be only temporary. The moves over the weekend could be part of the negotiating game and Saudi Arabia and Russia will eventually compromise. But if this situation persists, nothing can stop the price of oil from falling to its lowest level in at least 5 years.

"If a real oil price war were to take place, there would be many parties affected," said Badr Jafar, president of UAE Petroleum's Crescent Petroleum. "Many countries will have to prepare for economic and geopolitical shocks."

The sharp drop in oil prices will hurt oil producers around the world, especially Venezuela and Iran, economies that have come under pressure from US sanctions. Oil-dependent developing countries like Nigeria, Angola and Brazil could suffer significant recession.

Lower prices will also put additional financial pressure on US oil companies, dozens of which have been shut down in recent years. Oil companies fired workers in Texas and other oil-producing states.

The last time Saudi Arabia and other OPEC members allowed an increase in global oil supply to fight shale oil producers in the US was in late 2014, causing oil prices to drop below $ 30 a barrel. However, this measure failed because American companies tried to increase production and investors continued to pour money into businesses. In 2019, the United States is the world's largest oil producer.

In 2016, Russia and OPEC joined forces to boost oil prices by agreeing to cut production in the past three years.

Russia has gained significant political influence in the Middle East by associating with OPEC for the past three years. But now Russia has chosen to go alone, refusing to cooperate with OPEC. Experts say they want to target the US shale oil industry. Russia believes that the reduction in output will only help the field to live healthily, helping the US to keep hands on Russian customers.

As for Saudi Arabia, the cooperation with Russia over the past three years has helped strengthen OPEC's strength at a time when they were threatened with shale production from the United States. The Saudi reaction to Russia's "face-to-face" move may not actually be in retaliation for Russia, but for America.

"Russia has always said it wants to fight the shale oil industry. Now Saudi Arabia is one step ahead of the Russians to declare war on the US shale oil," said Johannes Benigni, founder of JBC Energy. Group, said.

Experts say falling oil prices will certainly affect the economies of Saudi Arabia and Russia, but they accept that to achieve their goals. Saudi Arabia believes that the current strategy will not fail as it did in 2014, because Wall Street has been frustrated by the sluggish returns on oil investment and small and medium-sized companies that are carrying large debts.

Chris Midgley, head of global analysis at S&P Global Platts, points out that Saudi Arabia has the lowest production costs and low debt so it can rely on foreign exchange reserves to defend.

Midgley added that Russia "could simply let the ruble slip." Meanwhile, "the US shale oil industry will certainly have to take a hit. They are unlikely to change output quickly because many activities have been scheduled and scheduled in advance," Midgely said.

Ryan Lemand, senior managing director of ADS Investment Solutions, assesses that the Gulf Cooperation Council countries (GCC - the alliance of Arab countries in the Gulf region except Iraq) have large foreign exchange reserves so they can stayed for a period of time when oil prices were low.

"They can hold out for a year or two. Other parties cannot. I think Russia will not last long. Russia will then return to the OPEC + arms just like a few years ago," Lemand said.

Meanwhile, Chris Weafer, senior partner at Macro Advisory, pointed out that "the Russian currency is flexible while the Saudi riyal is tied to the volatility of the USD (riyal pins to the USD at a fixed exchange rate). ) ". "That means Moscow is unlikely to be the first concession, certainly not in 3 to 6 months," he said.

"The big goal of both could be shale oil producers in the US," Weafer said.

Beyond the battle for market share, Russia may be seeking retaliation for Washington's recent energy sanctions. Three weeks ago, the Trump administration imposed sanctions on a subsidiary of Russian oil conglomerate Rosneft for supporting the Venezuelan President Maduro's government.

"Russia is not simply targeting shale oil companies, it wants to target US sanctions and Washington has done so because of its abundant energy supply thanks to shale oil." , Helima Croft, from financial firm RBC Capital Markets, writes.

Croft said Igor Sechin, CEO of Rosneft and a confidant of Putin, appears to have persuaded Moscow to challenge the US shale oil industry. "Like Putin, Sechin comes from Russian intelligence and is a nationalist," Croft wrote. "Undermining America's energy advantage is not only attractive to him in terms of profit but also ideologically."

"All will be hurt, including Russia," Bjornar Tonhaugen, from energy research firm Rystad Energy, said of the impact of falling oil prices. "The benefit of this move is of course it will also hurt the US".

The question is what Trump will do. The United States and Saudi Arabia are allies, Riyadh depends on the supply of US military equipment so Trump can influence the country. He spoke to the Crown Prince of Saudi Arabia, discussing the oil price war on 9/3. Trump has also made it clear he is willing to use tariffs and sanctions to achieve political purposes.

"If this is President Obama, you would expect the administration to do nothing and let the price of oil adjust itself," Weafer said. "But with President Trump, you cannot predict what he will do."