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24 Apr 2020

Politics of oil

There has been a seismic change in global oil markets, with potentially devastating long-term risks to the global economy and geopolitics. Portfolio manager and resources analyst MIKE TOWNSHEND looks at the politics of oil.

On 6 March 2020, Saudi Arabia stunned the world. Global oil demand was already slumping on the COVID-19 pandemic. But then the oil-rich kingdom announced it would not lead OPEC production cuts as the world expected. Instead, the Saudis would increase production and offer discounts for increased volume. 

The oil price responded viciously. In one week, Brent crude nosedived 40% from $50 per barrel to $30 per barrel. Belated production cuts announced by OPEC and its allies will unlikely offset the dramatic fall in demand.

The oil market is undoubtedly the world’s largest commodity market. It is bigger than all mined raw-material markets combined. We have built the modern economy on a global logistical supply chain that cannot function without oil.

Oil fuels aeroplanes, ships and motor vehicles — think how dependent any economy is on imported goods. We have also all become accustomed to affordable travel: far-flung holidays and the daily commute. And there is a complicated downstream industry built on oil derivatives, from plastics to detergents, clothing and pharmaceutical products.

The vibrant US economy is easily the largest global oil consumer. Since the 1970s it has also been the biggest oil importer, heavily dependent on Saudi-led OPEC supply. Saudi stability in the strife-torn Middle East has in turn demanded costly US political and defence support. 

However, a decade of elevated oil prices has attracted higher cost producers, notably US shale frackers. US oil production has doubled in ten years. It is now the world’s largest oil producing country, eclipsing even Saudi Arabia.

As a net producer, the US could re-evaluate its expensive and divisive involvement in the Middle East. This is not good news for a Saudi leadership grappling with a changing world order.

Saudi Arabia still has the largest oil reserves in the world. It is also at the bottom end of the cost curve. With rising electric vehicle (EV) consumption, the prospect of peak oil before 2030 looms as the country loses runway to act.

By suppressing oil prices now, the Saudis will squeeze higher-cost producers out of the market. This includes the US frackers, threatening newfound US oil independence. The political ramification is continued US political and defence support. At least for now.

On the other hand, China has limited oil resources. It is not by chance that the Chinese are at the forefront of research into new EV technology. The economic behemoth is now the largest oil importer. The Chinese could step into the Middle East vacuum if the US reduces its influence.

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