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Russia has edge in oil price war with Saudi

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      Boston - The oil price war between Russia and Saudi Arabia appears to be one that Russia is better able to withstand if it becomes a protracted battle.

      Last week, Russia withdrew from a pact with Saudi Arabia to limit crude production, which sparked a plunge in oil prices that has helped roil global markets, in conjunction with the impact of the novel coronavirus.

      Saudi Arabia is in a much weaker position from a balance sheet and internal political stability perspective than it was five years ago, the last time oil prices collapsed. Saudi's current fiscal break-even oil price is around $87, meaning that is the price needed to maintain a balanced budget, assuming constant production. If Saudi were to increase production by 20%, that would lower the break-even price by $10 per barrel. Even the lower break-even price is far greater than the recent $30-per-barrel price of oil.

      Thus, the Saudi budget is highly vulnerable to oil price moves: Every $5 change in oil prices corresponds to a 1.5% change in GDP. With $30 oil, the Saudi budget deficit could reach 18% of GDP. Central bank foreign exchange reserves (around $500 billion) could evaporate in three to five years, assuming sustained $30 oil and depending on the extent of private capital outflows.

      In contrast, Russia has never been better prepared for oil price volatility, having implemented significant reforms over the past five years. Although Russia's break-even oil price is $42 - higher than the current market - it has established a $125 billion National Wellbeing Fund that is sufficient to finance the budget deficit for 11 years, assuming oil prices stay at $30. Also, unlike Saudi's foreign exchange rate, which is pegged to the US dollar, Russia's flexible exchange rate can help absorb oil price shocks and help preserve the country's competitiveness.

      Bottom line: Russia has achieved major structural reform between 2014-2017, which gives it an important leg up at the start of a price war. Russia has moved to a more diversified economy, while Saudi is still all about oil.