Vladimir Putin meets desert justice

Bedouins, the nomadic Arab tribes that founded Saudi Arabia after centuries living in harsh desert conditions, have an austere historic culture and a harsh system of justice, including trial by ordeal. For serious unresolved disputes, they have a tradition of Bisha, or ordeal by fire in which an accused must take three licks of a red hot spoon drawn from a fire. The presence or absence of damage to the defendant’s tongue is taken as proof of guilt or innocence respectively.

Russia has been unwilling to cooperate with Saudi-led OPEC’s proposed cut in production to offset the global drop in oil demand from coronavirus economic effects. Russian President Vladimir Putin has stated the then prevailing $50/barrel price was “a fair price, which suits us.” In announcing their price cuts and production increases that Goldman Sachs says could produce $20 per barrel oil, the Saudis are forcing Putin to take his first lick of a red-hot spoon.

This is not Saudi’s first application of desert justice to uncooperative oil partners. After the 1970’s, when oil prices more than doubled following the Arab oil embargo in 1973 and again with the fall of Iran’s Shah in 1979, increases in production and conservation produced a 1980’s oil glut. To prop up prices, Saudi Arabia cut its production from 10 million barrels per day to 3.5 million barrels per day. Tired of bearing OPEC’s full load of price support amid cheating by its partners, the Saudis cut prices and boosted production at the end of 1985. Adjusted for inflation and for changes in the dollar’s foreign exchange value, this brought U.S. domestic oil prices from around $50 per barrel in November 1985 to roughly $22 per barrel by March 1986. These prices eerily parallel today’s levels.

OPEC always has had a “herding cats” problem. Its members include a mix of countries with varying needs, from high population, relatively low production nations such as Nigeria that are reluctant to cut output to high production, to low population Arab states with ample financial reserves that can afford short-term cuts. Accordingly, it took until the end of 1986 for the cartel to reach an output agreement that ultimately brought oil prices up near today’s equivalent of $41 per barrel by July 1987. For a while, Saudis were able to get their own higher production levels and cooperation from their partners that enabled somewhat higher prices.

A second application of Saudi desert justice to the oil markets was an attempt to wipe out U.S. oil fracking production that began in November 2014. The Saudis were frustrated by oil prices falling with 70 percent increases in U.S. production and refused to cut their own production to support prices. U.S. oil prices fell from today’s equivalent of $130 per barrel in June 2014 to $35 per barrel by January 2016. The Saudis staggered U.S. production, which fell 6 percent in 2016, but came nowhere close to knocking it out. U.S. frackers had a clean tongue, and the Saudis moved on to work out a new OPEC agreement in November 2016 and a joint agreement between OPEC, Russia and other producers, known as OPEC-Plus, the collapse of which precipitated the current price war. With OPEC-Plus cooperation, prices rose to $55 in early 2017 and as high as $70 in 2018 before their recent fall.

For all their oil market power, the Saudi price war record is mixed. Their 1986 price war brought increased OPEC cohesion. In 2015-2016, their attack on U.S. fracking failed but led to the OPEC-Plus cooperation. In 1986, prices fell over 50 percent, the price war took a year to resolve, and prices climbed back 90 percent (still less than where started). In 2015-2016, prices fell 70 percent while resolution took two years, and prices subsequently rose 60 percent, again to lower levels than when the price war began.

Both the Saudis and Russians are prideful countries. Any contest of wills would likely come down to a contest of bank accounts. Each has a half a trillion of foreign-exchange reserves, but neither wants to dissipate their wealth, so an extended price war is less likely. Russia is tightly managed from the standpoint of macroeconomics, and Putin may not desire multiple licks of the red-hot spoon. History indicates chances of a full price recovery to levels in the $50s are limited.

Douglas Carr is a financial markets and macroeconomics researcher. He has been a think tank fellow, professor, executive and investment banker.