Lost to many in all the furor and panic over the coronavirus freight-training stock and commodity markets is another important—and likely long-lasting—event: Saudi Arabia declared an oil war with Russia.

Characterized by several commentators as a global “game of chicken,” this war could impact more people than President Trump’s China war.

In fact, for those of us with long memories, there could be more disruption than any since the 1973 oil embargo, except that this time it will be the exact opposite—a glut. But the U.S. will still be affected, especially in a certain sectors and geographic locations important to the cattle industry.

What brought this on? For years, the world’s biggest oil producers were Saudi Arabia, the dominant producer in OPEC and Russia. They were the big producers and exporters. Up to now, the Saudis exported 70% of their production and Russia, 60%. Energy contributes 50% of Saudi GDP and 30% of Russia’s. Those numbers have allowed OPEC to hold 50% of the world market. That huge market share allowed OPEC to hold the world hostage in 1973, but it brought on a global recession.

Up from the ground came a bubblin’ crude

Then along came America’s marriage of old technology (fracking) and new technology (horizontal drilling) and suddenly there was a new player in the sandbox, upsetting the old order. The U.S. went from a major oil importer to a major exporter, with production half again more than Saudi Arabia or Russia. 

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OPEC’s market share dropped to 30%. Yet there was too much supply on the world market. In 2014, after oil prices dropped to under $30 a barrel, OPEC and Russia agreed, after difficult negotiations, to joint production cuts to force the price of oil higher.

That difficult partnership has been in effect since but only with additional production cuts by both parties to offset increasing U.S. production.

In recent weeks, OPEC, led by the Saudis, has been negotiating to make further production cuts, given falling demand from the coronavirus’ impact on world demand. But this time, the Russians refused to go along. 

Furious, the Saudis decided that if they couldn’t get better revenue from production cuts to prop up the price, they would instead flood the market with oil and get money from selling lots of cheaper oil. They began offering customers discounts of up to $13 a barrel beginning in April. When Russia found out what the Saudis were going to do, they announced production increases also, adding to the global glut.

Price break

When the news broke, the price of oil dropped nearly one-third, to $30 a barrel Monday and only recovered to the mid-30s on Tuesday. In addition, over 2 million barrels of existing cut agreements expire the end of March, meaning even more oil could be put on the market. 

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Experts say the production levels the Saudis are planning, over 12 million barrels per day, actually exceed their daily capacity, meaning they are willing to draw upon reserves to inflict pain on the Russians, and, in addition, to America’s shale oil producers. The Saudis have a network of crude storage in three places around the globe, something Russia does not have.

It is noteworthy, however, that U.S. shale producers have continually improved their efficiency, meaning lower and lower break-evens. Estimates are that, from existing wells, they have lowered break-evens to perhaps $37 a barrel. Even so, there will be damage to oil producers in places like Texas, North Dakota and, likely, non-shale producers in Alaska. Damage will be somewhat lessened nationally, as exports only amount to roughly 13% of U.S. GDP, with about half of those exports going to Mexico and Canada.

Part of this equation, of course, is the drop in demand from a less than robust global economy, before the coronavirus problem. Guess who is the world’s biggest oil importer?  China imports 50% of world production normally, but that demand will be lessened for the near future.

How long could this go on? 

Observers say Russia has built up a reserve of $570 billion to give them room to lose oil revenue for years. By cutting expenses, they can limit damage to the national budget. It is speculated the Russians tired of the production cuts because they limited the growth of Russian oil companies.  The Saudis do not have that big a cash pile, but they have huge oil stores. They could end up running a 15% government budget deficit at these oil prices.

This fight was not anticipated by the world’s oil market experts. Some suggest the Saudis did not expect the Russians to pull foot and turn up their own spigots. No one seems to know how much of the Saudis strategy is aimed at the Russians and how much is designed to weed out some American shale producers already skating on thin ice. 

It is the theory of some that the Russians are more interested in damaging shale producers. Many expect the lower crude prices to last a while, with the major drop in demand due to the coronavirus and American production not likely to drop off right away. Should the virus make substantial additional inroads, low prices could continue longer or even drop further. A regular OPEC meeting is scheduled for mid-June, but emergency meetings could be held in April or May.

Of course, the rest of America, including, and perhaps especially, agriculture, is looking forward to lower gas prices. Who would have thought a week ago that feedyards, ranchers and farmers would have to opportunity to contract for oil at under $40 a barrel equivalents?

It is interesting that in debating the impact of the oil wars on the global economy, at least one expert specifically noted that all the damage to economic activity caused by the virus panic will cause much more damage than the virus is likely to do, unless it suddenly morphs into something like the Black Plague or the Spanish Flu of 1918.

Steve Dittmer is a longtime beef industry commentator and executive vice president of the Agribusiness Freedom Foundation.