07.04.2020
The Pandemic and the Price of Power
Opinions
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Rawi Abdelal

Director of Harvard’s Davis Center for Russian and Eurasian Studies.

The medium-run future of energy markets will be dependent primarily on the course of the pandemic and the effectiveness of central banks and governments, rather than on the supply decisions of Russia and Saudi Arabia.

The world’s energy markets have endured simultaneous demand and supply shocks. The COVID-19 pandemic has brought national economies to a sudden stop. Disagreements particularly between Russia and Saudi Arabia about how energy producers should react to the collapse in demand have led to an expansion of output and a struggle for market share. The sharp decline of prices has put incredible pressure on higher-cost, lower-margin producers, such as U.S. shale firms.

 

What comes next?

 

The consolidation of the U.S. shale industry is at hand. Hundreds of smaller firms will declare bankruptcy. Larger firms will accumulate tracks of land that will have to await a higher-price future to be economically viable again.

For other oil-producing countries, the implications are straightforward. The Russian federal budget will likely be pushed into deficit. Saudi Arabia’s Vision 2030—already quixotic—will become impossible to achieve. This will leave the country desperately dependent on oil revenues and on its long-term trajectory toward economic disappointment.

Much attention has been paid to the price war between Russia and Saudi Arabia. Perhaps soon there will be a truce. President Donald Trump and his advisers are considering ways to put pressure on the two oil producers to cut production. Trump’s leverage on Russia is, of course, limited, but greater pressure could be brought to bear on Saudi Arabia.

The primary uncertainty, however, is demand. Almost no imaginable amount of production cuts by either Saudi Arabia or Russia could stabilize prices at a higher level at the moment.

So, the fate of the oil price—and of many of the world’s energy firms—will depend on two key influences on the medium-run future of demand.

One is the length of this sudden economic stop. Will our quarantines end by June or linger through summer months? Will our quarantines be intermittent through the autumn as we wait for an effective vaccine and widespread antibody testing to determine who among us has already been exposed and might safely resume our lives?

The other influence is the effectiveness of central banks and governments in preventing the inevitable recession from becoming an economic depression. With so much of the economy shut down and unemployment increasing alarmingly, many small- and medium-sized firms may not survive. The foundering real economy will put enormous pressure on the financial sector. If central banks and governments manage to support effectively households, firms, and banks through these months, then the recovery of demand in the third and fourth quarters of 2020 might be robust. If they fail, however, we face an extended and profound economic disruption that would restrain demand for much longer.

Thus, the medium-run future of energy markets will be dependent primarily on the course of the pandemic and the effectiveness of central banks and governments, rather than on the supply decisions of Russia and Saudi Arabia.

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