From what I understand the Saudis wanted to reduce oil production and increase price, and Russia did not. So, to punish Russia, they are increasing production and reducing the price.

This strikes me as slightly weird - if this is really what is happening (please correct me if my facts are wrong), surely this is only a temporary move from the Saudis as it is the opposite to what they want. Any insights?

  • There are also north American oil producers... – Martin Schröder Mar 10 '20 at 17:27
  • Fizz, thank you yes it does. I missed that thread as the title doesn't exactly match my question which was not why Russia declined, by why the Saudis flooded the market. – John Smith Mar 11 '20 at 3:06

Game theory point of view

We can view it from the game theory point of view, with a simple prisoner's dilemma situation.

Let's keep it simple with only two oil producers, Saudi Arabia and Russia. Both can either decrease production, or sell all they can.

The less oil is sold, the more each barrel is sold for.

The best situation if we add their revenues is keeping production low, and prices high.

However, if the prices are high, one could sell all their oil. High prices, lot of production, maximum profit.

But this of course, doesn't please Saudi Arabia: the prices are high only because they produce less. They could earn more if they sold more.

We arrive to a Nash equilibrium, where both sell all they have.

Sure, the first situation would be best, but it isn't stable, as it just require one cheater to break the equilibrium.

Different production costs

In addition to the analysis from game theory, it should also be highlighted that both countries don't have the same extraction costs. It costs less to Saudi Arabia to extract oil, so they can afford it, as even with low prices, they still earn money, whereas countries extracting lower quality oil, like Russia, could lose money from selling too low.

This is however true only in short-medium range, as Saudi Arabia is much more dependent on oil selling than Russia is for their economic growth.

  • Re "They could earn more if they sold more". Economics are unfortunately not that simple. (If by "earn" you mean maximize profit.) Look up optimal pricing theory. (It's not me who downvoted your answer, by the way.) – Fizz Mar 11 '20 at 2:44
  • Modelling the oil market is hardly a trivial thing. Lots of models have been offered over the years. researchgate.net/publication/… – Fizz Mar 11 '20 at 2:56
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    Thanks for your post, but I admit I don't really understand how your response explains the specific decision made by Saudis. – John Smith Mar 11 '20 at 3:06
  • “This is however true only in short-medium range, as Saudi Arabia is much more dependent on oil selling than Russia is for their economic growth.” Are they? Clearly it's even more important for Saudi Arabia (40% of GDP vs. 20% for Russia) but when looking at exports the difference is less dramatic and it's important enough to be critical for Russia too. – Relaxed Apr 8 '20 at 20:58

There is a deal (still active till the end of March 2020) between the Organization of the Petroleum Exporting Countries (OPEC) and Russia. The deal assumes mutual cut of oil production in order to artificially lower the overall supply and keep the price high.

The original deal has been initiated by Russia (despite it is not a member of OPEC) and signed back in 2016.

The new Coronavirus outbreak in the beginning of 2020 has reduced the market demand. In order to keep prices high, this deal has to be prolonged (or even strengthened). This was very agenda for OPEC-Russia meeting in Vienna. The 14 OPEC member countries had wanted to cut output by 1.5 million barrels a day, or about 1.5% of world production.

Most naturally, the cut has to be mutual, because if one party does not cut the production, they "flood" the entire market, prices keep falling, and those who agreed to cut their production simply lose profit for no fruit at all.

The Russians declined the deal, hence the other oil producers are free from their obligations as soon as the old deal expires.

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