A Game of Chicken … With Oil

A worker checks the valve of an oil pipe at an oil field owned by Bashneft company near the village of Nikolo-Berezovka, northwest from Ufa, Bashkortostan, January 28, 2015. New European Union sanctions against Russia could include further capital markets restrictions, making it harder for Russian companies to refinance themselves and possibly affecting Russian sovereign bonds and access to advanced technology for the oil and gas sectors, EU officials said on Wednesday. REUTERS/Sergei Karpukhin (RUSSIA - Tags: ENERGY BUSINESS INDUSTRIAL POLITICS) - RTR4NCM9

Source Sergei Karpukhin/Reuters

Why you should care

This gutsy strategy could play out brilliantly — or leave both countries bleeding black gold.

Simonomics: A regular look at the global economy from a former staff columnist at The Wall Street Journal. 

In the world of oil, a little noticed but fascinating game of chicken has broken out. And the unblinking eyeballs happen to involve a guy named Putin and a prince who enjoys fast cars, all 200 of them that he supposedly owns.

Does any of this ring a bell? As some of you may have surmised, the two biggest so-called petro giants, Russia and Saudi Arabia, are locked in a battle to maintain control over the global dominance of oil that’s slowly slipping away as other forms of energy like natural gas begin to grow in importance.

Both countries produce gigantic sums of oil: 11.6 million barrels a day for Saudi Arabia, and 10.9 million for Russia, according to the U.S. Energy Information Administration, a government body that tracks this industry. That’s enough to place them second and third in the world, behind only the United States.

The two countries should slow down how much they’re tapping those oil wells. But neither can or is willing to.

And that’s where the problem begins. As anyone who’s been at the gas pumps lately has noticed, the price of oil is dropping like a heavy stone. It’s now around $43 a barrel, less than half what it was a year ago. Few commodities have fallen that quickly, and here in the U.S., the country can stomach the drop because the economy benefits from cheaper energy costs. But Saudi isn’t quite that lucky, since an estimated 80 percent of its budget relies on oil, according to the CIA World Factbook. As for Russia? Almost 70 percent of its export revenue is oil based, the EIA says.

The obvious answer when prices drop is to reduce supply. In other words, the two countries should slow down how much they’re tapping those oil wells. But here’s where it gets pretty intriguing: Neither can or is willing to.

Instead, both are continuing to sell as much oil as they possibly can, regardless of what that does to world prices, says Max Pyziur, analyst at the Energy Policy Research Foundation. There is a logic to this. They’re holding steady with their prices until they’ve secured relationships with the countries that need energy. Putin, for one, wants Russia to keep pumping 10 million barrels a day through the end of this decade, while Saudi is taking a similar approach to maintain ties with its customers, says Emily Stromquist, an analyst at research consulting Eurasia Group in London.

But how long can this go on? Quite a while, with some forecasting production cutbacks as far off as 2017. No wonder then, as Greg Priddy, an oil analyst at Eurasia Group, puts it, “The oil world is in a battle for market share.” What’s more, it helps that Russia and Saudi Arabia have government cash reserves that top $300 billion and $700 billion, respectively.

Still, it’s not hard to envision an endgame that won’t be all that pretty for these great big oil leaders. The more they both keep pumping oil and adding to the glut, the more likely they are to burn through those reserves. And that’s where the real financial pain comes in: After all, the funny thing about cash reserves is they can only be spent once.



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