• The increases would pressure the U.S. shale industry, which needs prices to stabilize above $40 a barrel
  • Crude oil futures were recovering from Monday's 25% fall, trading above $33 a barrel
  • Both Saudi Arabia and Russia have the capacity to keep a price war going at least five years

Crude oil futures made a modest recovery Tuesday following a 25% plunge Monday triggered by a price war launched by Saudi Arabia and Russia as the two countries announced massive production increases.

The Saudis announced an output increase and price cut during the weekend after Russia refused to go along with OPEC plans to cut production to stabilize prices as demand dropped as a result of the spread of the coronavirus, which has cut demand by China and other nations drastically.

Crude oil futures were up about 8% in midmorning trading Tuesday to $33.66 a barrel. Brent crude, which rose fractionally Monday after first falling by double digits, was up more than 7% to $36.96 a barrel.

The White House said President Trump discussed energy markets with Saudi Crown Prince Mohammed bin Salman Monday while U.S. Treasury Secretary Steven Mnuchin told Russia’s U.S. ambassador energy markets need to remain “orderly.”

Despite the jawboning, Saudi Aramco announced Tuesday it would increase supplies to a record 12.3 million barrels in April, a 25% production hike and 300,000 barrels above its maximum production capacity. Some of that production will come from the “Neutral Zone” with Kuwait, which is not included in Aramco’s capacity. Russia responded with a 500,000 barrels a day increase to put its output at a record 11.8 million barrels a day.

“There is a significant amount of market posturing going on between Saudi Arabia and Russia,” Jaafar Altaie, managing director of Abu Dhabi-based consultant Manaar Group, told Bloomberg. “They’re both getting ready to fight a pretty aggressive price war.”

Both Saudi Arabia and Russia want to recapture market share lost to U.S. oil shale production, which the Energy Information Administration estimated at 7.7 million barrels a day in 2019, about 63% of total U.S. oil production. To break even, however, shale production needs the price of oil to remain above $40 a barrel.

"The oil price cuts are targeted against the growing U.S. energy production sector as it is an increasingly greater threat to the Middle East and Russian oil sales. It is a big gamble from producers that are increasingly facing existential threats from U.S. production," Steven Skancke, chief economic adviser at Keel Point, told IBTimes.

The U.S. Department of Energy denounced the Saudi and Russian moves.

Who will win the price war is an open question. Saudi Arabia has more reserve capacity and could dip into its strategic oil stocks to maintain pressure while Russia has a $150 billion wealth fund it could use to bolster the ruble to cover losses.

The Russian Finance Ministry said it could withstand prices between $25 and $30 a barrel for as long as a decade.

A $35 a barrel price for Brent crude would produce a 15% deficit in Saudi Arabia for 2020 if government spending isn’t altered. The Abu Dhabi Commercial Bank said Saudi foreign reserves could last about five years without other funding sources.

“Welcome to the free market,” Bob McNally, founder of consultant Rapidan Energy Group and a former White House official, told Bloomberg. “The world is about to learn very swiftly how important a swing producer is for stability, not only for the global oil market but the broader economy and geopolitics.”

“It’s always tough to pick a fight with Russia, with Putin,” Robert Johnston, director of global energy and natural resources at the consultancy Eurasia Group, told CNBC. “Now you have a standoff between Saudis and Russians over who will blink first. I do think this is going to last a while; I think this could be two to three months at least.”