(Price) War Is Hell.

One day after oil prices plunged the most since 1991, the Saudis let Russia know they’re serious about the oil price war.

Over the weekend, Aramco hiked OSPs in the opening salvo of an economic conflict that upended global markets and triggered the worst day for Wall Street since the financial crisis. On Tuesday, the state behemoth confirmed plans to orchestrate a giant output hike.

Aramco will supply a record 12.3 million b/d next month, representing a 25%+ increase from February, when the Saudis churned out around 9.7 million b/d.

Amusingly, Bloomberg notes that the figure is above Aramco’s “maximum sustainable capacity, indicating that the kingdom is even tapping its strategic inventories to dump as much crude, as quickly as possible, on the market”.

Goldman said Sunday that Russia may believe the shakeout in US shale (which Putin is targeting) will be swift. “[A] faster rebalancing – which may in fact be even quicker given the ongoing coronavirus-led contraction – may itself be the catalyst for Russia to hold off on any output agreement until it is completed and may help explain why this market share battle is happening now”, the bank remarked, adding that “in particular, there is no longer a wave of long-cycle projects coming online, with the last of these projects starting in 2020”.

(Goldman)

Crude prices trimmed gains on the latest price war news, but quickly resumed a nascent rebound from Monday’s abject madness. Any such rebound could prove fleeting.

There’s no recent precedent for the spike in volatility, just as you have to go back to 1991 to find a comparable price decline.

Russia wasted no time responding. Alexander Novak immediately said Russia can ramp its own production by 500k b/d, bringing output to a record 11.8 million b/d.

While the Saudis have the spare capacity advantage, they most assuredly do not have the fiscal upper-hand. Riyadh would end up running something on the order of a 15% deficit in 2020 if Brent stays at $35 and Mohammed Bin Salman doesn’t cut spending.

The kingdom is targeting a 6.4% fiscal deficit this year, a figure that assumes Brent at $65.

Yields on the kingdom’s 2049s surged on Monday, and while shares of Aramco recovered Tuesday, they’re still below the IPO price, even with likely state support.

“Despite a marriage of convenience on oil between President Putin and Crown Prince Mohammad, this relationship has always been fragile”, SocGen’s Michael Haigh and Florent Pelé wrote Monday, adding the following fiscal color, which just reiterates why the ill-fated betrothal was so tenuous:

Russian oil companies see the cuts as a self-destructive mechanism to give volumes to the US shale industry. According to Argus Global Markets, the two nations view production cuts differently due to different budgetary pressures. Russia relies on oil revenues for 37% of its budget and can run a fiscal surplus of 0.8% of GDP with Ural oil prices at $57/bbl. For Saudi, oil makes up 65% of the nation’s budget, and a $50bn budget deficit is assumed this year with oil at $65/bbl. 

But it’s not all good news for Russia. Moscow is outgunned in terms of near-term firepower thanks to the Saudis’ spare capacity and ability to tap a vast network of storage terminals from Rotterdam to Okinawa to Sidi Kerir.

On Tuesday, the Bank of Russia brought forward foreign currency sales as the ruble dropped to the lowest since 2016. Russian equities came off a holiday to a bloodbath, although losses were trimmed. Local 10-year yields jumped 57bps.

On Monday, the Russian Finance ministry said the sovereign wealth fund (which holds some $150 billion) could be tapped in order to cushion the budget blow and help the country ride out a storm that sees crude prices drop to even $25 per barrel for a decade.

Russia also labors under the “international pariah” label in the west thanks to an ongoing campaign of malign activities including election tampering in democracies, attempted executions on foreign soil and interventions in support of dictators. Clearly, Saudi Arabia is itself a dictatorship prone to political executions on foreign soil, which means there’s something absurd about picking sides in this clash of the titans.

In any case, the overarching point was captured succinctly on Tuesday by Rapidan’s Bob McNally. “Welcome to the free market”, he said.

Remember the good old days?