March 19, 2020 | 10 minutes read

The current crisis in oil

The tendency of the rate of profit to fall, its causes, and the inevitability of capitalist crisis, is explored in great depth in Marxist literature. What is clear from the immense body of theory, and the material conditions preceding the current economic crash, is that COVID-19 is not the cause.

The current crisis in oil

Last Monday, Russia refused to join Saudi Arabia and other oil exporting countries in making further cuts to oil production, in response to a depression in prices that has been blamed on the COVID-19 outbreak. The consequence is a price war between the world's largest oil exporters, with Saudi Arabia making deep cuts in the selling price, and Russia following suit.

A Short History of OPEC

The Organisation of Petroleum Exporting Countries (OPEC) was formed in the decades following the 2nd World War, as a challenge to the hegemony of the "Seven Sisters" oil companies, led by the USA. At the time, the USA was the world's largest producer and consumer of oil. The 5 founding nations, Venezuela, Iran, Iraq, Kuwait and Saudi Arabia agreed among themselves to regulate their exports of oil in order to support prices. Between 1961-70, OPEC's membership grew to incorporate Qatar, Indonesia, Libya, UAE, Algeria, Nigeria, Ecuador and Gabon, collectively representing more than half of the world's supply of oil. OPEC is a clear example of the necessity within capitalism for the formation of monopolies and cartels in order to maintain economic viability, though the cartel has had at times an anti-imperialist character, with a significant majority of OPEC nations participating in production cuts and an oil embargo against the imperialist axis in the 1973 Arab-Israeli War. In the sixty years since its formation, OPEC has frequently stepped in with collectively agreed production cuts to uphold higher oil prices and maintain profitability, but not without consequence. A high oil price leads to an expansion of the available supply, as inefficient means of extracting oil that would be unprofitable at lower prices become viable, which in turn exerts a downward pressure on the price of oil and disincentivises the more efficient oil producers from restricting production.

American Shale and OPEC's Decline

"Where it is possible to capture all or the chief sources of raw materials, the rise of cartels and formation of monopolies is particularly easy. It would be wrong, however, to assume that monopolies do not arise in other industries in which it is impossible to corner the sources of raw materials." - Lenin, Imperialism

As of 2018, OPEC's 14 members represented only 35% of global supplies, but 82% of proven reserves. This relative decline in the share of the global supply is primarily attributed to the reversal of the trend in US oil production since 2008, which had been in steady decline from its peak of 9.6 million barrels per day in 1970. The massive expansion of the Shale Oil industry has recovered American production from the 2008 low point of 5 million b/d to a new high of 10.9 million b/d in 2018. This expansion was a primary factor in the 2014 crash in oil prices, coinciding with demand for oil from the BRICS nations growing more slowly than it did in the decade prior.

Amid overproduction and underconsumption, oil prices plummeted from $110/barrel to $50/barrel in a year, hitting a low point of $36/barrel in February 2016. The cartel was compelled to expand, and a new format known as OPEC+ (or the "Vienna Group") brought the 14 OPEC nations together with Russia, Mexico and 8 other oil producing countries. Collectively controlling 55% of global supplies and 90% of proven reserves, OPEC+ re-established the economic weight needed to stabilise prices and ensure the continuity of oil profits against the rapidly expanding US supply. From 2016 to 2018, production cuts of 1.8m b/d, in combination with an additional 1m b/d decrease due to the economic war on Venezuela and the escalation of the war in Libya, increased prices to around $75/barrel.

OPEC and its successor are not a union of equals. The cartel functions as a dictatorship of the largest members, who effectively buy off the smaller producers by permitting them to pump some small volume of oil, under threat of crashing the prices and decimating their economies. The small producers have won only the right to pump oil within their quota, and have surrendered to the larger producers the right to determine production and prices over a much more substantial monopoly than they would otherwise control. This is clearly demonstrated by the friction within the Vienna Group that the unplanned additional production cuts from Venezuela and Libya has created. Of the 24 cartel members, 20 are pumping close to their capacity limits. Russia, Saudi Arabia, Kuwait and the UAE are the only members with capacity to spare. Russia proposed to expand OPEC+ production by 1.5m b/d, and in June 2018, a 'collective' decision was taken to correct the underproduction by 1 million b/d, granting the 4 members, but in particular Russia and Saudi Arabia, a larger market share and a stronger grip over the cartel, at the smaller producers' expense.

Great Power Competition

"Monopoly hews a path for itself everywhere without scruple as to the means, from paying a “modest” sum to buy off competitors, to the American device of employing dynamite against them." - Lenin, Imperialism

The restoration of oil production in the USA has been marked by a qualitative shift in their geopolitical strategy. The USA no longer needs to "secure" the production of oil in countries like Afghanistan or Iraq for its own consumption, as it has done in decades prior. The USA now stands to gain considerably more from shutting down oil production outside its borders than it does from controlling it. The economic war on Venezuela, and the continual fermenting of chaos and destruction in the Middle East, are components of this. Contrary to the popular narrative, the destruction of the Iran deal by the Trump administration and the reapplication of the sanctions regime is not explained by the alleged risk of a nuclear-weapons capable Iran, nor a simply an expression of the obsessive racism & Islamophobia of the American ruling class. It is simply, as Trump puts it, "the worst deal of all time". On the deal's own terms, it has completely achieved what it set out to do. But the cost, which was the alleviation of sanctions and the normalisation of economic relations, in particular oil exports, make it an incredibly bad deal for American oil. The shift in the US military strategy against Iran, culminating in the assassination of General Qasem Soleimani, amount to nothing less than an attempt to provoke a regional war that would decimate regional oil production, send oil prices skyrocketing and bring the US significantly closer to a global oil monopoly.

These manoeuvres have forced a change in the approach of the Saudi Arabian monarchy. The US is no longer an ally but a competitor, and it's military strategy is highly likely to provoke intense retaliation against Saudi Arabia itself, demonstrated by the damage to Saudi oil production inflicted by Houthi drone strikes which were able to evade the US-supplied air defences. Thus, the two largest producers of the Vienna Group, Saudi Arabia and Russia, are united in their frustration with restricting their own supply only to face steadily rising US production. In effect, OPEC+ is subsidising US Shale.

There are two price points for oil producers that are significant to consider. The first is the profitability break-even point, the price above which oil extraction companies will make a profit on their sale. The second is the budget (or "fiscal") break-even point. This is the price that a country's government needs to balance the national budget with tarriffs on oil exports. The budget break-even point is generally higher than the profitability point, particularly for nations whose main export is oil. Both are significant for different reasons - if the price is too low for the producer, the oil could stop flowing. If the price is too low for the government, they could be forced to resort to predatory IMF financing and austerity measures, with the consequent social instability and mass deprivation. Many smaller OPEC countries need an oil price above $100/barrel to balance the national budget. Russia's finance ministry announced on the 9th March that they could balance the state budget for another 10 years with an oil price as low as $25-30/barrel. Saudi Arabia can pump oil profitably much lower than Russia can, but has a significantly higher fiscal break-even point of $88/barrel in 2018, aiming to reduce this to $55/barrel by 2021. Conversely, while US Shale requires an average $50/barrel to break-even on profits, the US government budget does not depend on oil exports.

In this context, the breakdown of the Vienna Group format, triggered ostensibly by Saudi Arabia & Russia being unable to come to an agreement over new production cuts, may actually be obscuring a new reality. The price war "between" Russia and Saudi Arabia represents a (temporary) united front against the American monopolists. Arriving at exactly the moment of acute weakness in the American economy, with oil already facing a dip in prices because of the broad suspension of manufacturing and transport in China due to the COVID-19 quarantine measures, alongside the effect of a pandemic on the oil-hungry global travel industry.

These trends in great power competition over oil production, spanning decades, compel the conclusion that the crash in oil prices is not caused by the pandemic. The only possible relationship, where oil is concerned, is that COVID-19 has chosen the moment for the monopolists to wage a price war. It has no bearing on the need for such a confrontation.

All Roads Lead To Recession

Ostensibly in response to the COVID-19 outbreak, the US Federal Reserve Bank announced the first emergency rate cut since the 2008 recession on March 3rd. Markets continued to drop. 12 days later, another emergency cut brought the lending rate to zero, alongside a $700 billion Quantitative Easing programme and an expansion of "Repo" operations, which have been steadily growing since September, to $1.5 trillion. The markets responded by dropping further. Amidst this, the German government announced "unlimited liquidity", and the British chancellor promised "we will do whatever it takes", with an initial package of £330 billion and more to come. As this article was being drafted, Canadian Heavy Crude plunged below $8 per barrel.

Repos, or repurchase agreements, though now expanding on an unprecedented scale, significantly precede COVID-19. Repurchase agreements are a form of short-term loan. The two parties agree an exchange of collateral for cash, with a guarantee of swapping them back ("repurchasing") with interest after a given time period, usually overnight. Repos allow large investors to put their idle capital reserves to profitable use when they can't be exercised on the stock markets, which are only open for trading in business hours. Similarly, the large banks can utilise their investments as collateral to get the cash they need for settling accounts and to finance trading and lending, allowing them to wield larger volumes of capital than would otherwise be possible. The interest charged on repurchase agreements is typically close to the Federal Bank's target lending rate, but in mid-September, a full 5 months before the discovery of COVID-19, lending rates spiked from 2% to 10%, as significantly more cash was withdrawn from the repo market than collateral was coming in. The federal bank responded by expanding the volume of repurchase agreements that it offered to $75bn per day over the 4 days of the spike, to calm the markets. This was the first cash handout to the banks since the financial crisis, and this expanded, with swathes of overnight and longer-term repo operations being offered, culminating in $500bn available on the last day of 2019.

While the recent massive expansion of these facilities has coincided with the coronavirus outbreak, it is clear that the economic weakness that they are indicative of - a liquidity crisis in the lending sector - has been building for some time. A shortage of cash constitutes a 'supply-side' shock in one of the largest US commodity markets - debt.

The "treasury bond yield curve" measures the relative return on investment on treasuries of different durations. Treasuries, or treasury bonds, are parcels of government debt. The government sells them to finance its activities, and investors buy them with the peace of mind that unless the state collapses, the debt will be repaid. In normal circumstances, investors expect a higher rate of return for debts of a longer duration - capitalists loaning money to the US government for 10 years expect to get more back in 10 years than they would get back in 2 years on an equivalent 2 year loan. The yield curve, when the economy is expanding, reflects this - an upward curve. Prices and yields move in opposite directions, because the yield is the difference between the value at the point of sale and the value at maturity, when it is converted from a bond into cash by the issuing bank. For example, if a treasury bond that will be worth $1000 when it 'matures' is sold for $900, the yield is $100. If the sale price increased to $950, the yield would decrease to $50. An inverted yield curve - sloping downwards - is considered empirically the best predictor of a coming recession. In August 2019, the yield curve inverted. This happens when capitalists move their capital into long-term bonds for safekeeping. This raises the prices of longer term bonds, and reduces their yield. The only possible conclusion is that these investors were responding to something more fundamentally weak in the economy than a coronavirus outbreak that they had no way to anticipate.

The tendency of the rate of profit to fall, its causes, and the inevitability of capitalist crisis, is explored in great depth in Marxist literature. What is clear from the immense body of theory, and the material conditions preceding the current economic crash, is that COVID-19 is not the cause.

Sources

OPEC

"Russia Might Not Be Done With OPEC Just Yet" https://oilprice.com/Energy/Crude-Oil/Russia-Might-Not-Be-Done-With-OPEC-Just-Yet.html

Russia backs gradual, managed exit from oil cuts with OPEC https://www.reuters.com/article/us-russia-oil-opec/russia-backs-gradual-managed-exit-from-oil-cuts-with-opec-idUSKBN1EG11V

Russia agrees with Saudi Arabia to extend OPEC+ oil output deal https://www.reuters.com/article/us-g20-summit-putin-opec-idUSKCN1TU0AF

Oil Production Outputs

OECD https://data.oecd.org/chart/5Sfd 1971 – 2017, Annual 3 highlighted countries (RUS, SAU, USA)

https://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=pet&s=mcrfpus2&f=a

Oil Prices & Breakeven Points

"Russia can weather low oil prices for up to 10 years" https://news.cgtn.com/news/2020-03-09/Russia-can-weather-low-oil-prices-for-up-to-10-years-OIXgbRCQWA/index.html

"Why This Oil Crash Is Different" https://foreignpolicy.com/2020/03/09/opec-russia-shale-oil-price-collapse/

"Why Saudi’s former allies in Opec will be worst hit by oil crash" https://www.ft.com/content/85bc7cc4-62d8-11ea-a6cd-df28cc3c6a68

Breakeven Oil Prices Underscore Shale’s Impact on the Market https://www.dallasfed.org/research/economics/2019/0521

Saudi Arabia Leads Gulf Nations in Cutting Break-Even Oil Price https://www.bloomberg.com/news/articles/2017-10-31/saudi-arabia-leads-gulf-nations-in-cutting-break-even-oil-price

Repo Markets

https://www.bloomberg.com/news/articles/2019-09-19/the-repo-market-s-a-mess-what-s-the-repo-market-quicktake

https://www.reuters.com/article/us-usa-fed-repo-tools-explainer-idUSKBN1W30EJ

Reporting on Current Crash

Dow rallies more than 1,100 points in a wild session, halves losses from Monday’s sell-off https://www.cnbc.com/2020/03/09/dow-futures-fall-200-points-following-markets-worst-day-since-financial-crisis.html

U.S. Stocks Plunge as Coronavirus Crisis Spreads https://www.nytimes.com/2020/02/24/business/stock-market-coronavirus.html

Coronavirus: Fear returns to stock markets https://www.bbc.co.uk/news/business-51766782

Coronavirus: US central bank makes emergency rate cut https://www.bbc.co.uk/news/business-51726954

Coronavirus: Eight charts on how it has shaken economies https://www.bbc.co.uk/news/business-51706225