By itself, the idea of ​​Saudi Arabia and Russia launching a price war on oil in the midst of a global pandemic could not have been more foolish. From a game theory standpoint, however, it is a brilliant move, according to Antoine Halff, chief analyst at Kayrros and a research scientist at Columbia University’s Center for Global Energy Policy.

Analysts call the collapse of OPEC+ agreement and the abolition of supply cuts that have maintained the oil market’s balance for the past two years, with terms ranging from grandiose blunder to collective suicide.

However, a new model for the oil market, derived from renowned game theorists Pierre-Louis Lions and Jean-Michel Lasry, suggests otherwise.

In order to optimize their oil revenues, large low-cost producers such as Saudi Arabia – the “dominant monopoly” according to the terminology of gaming theory – must balance price and market share, the model shows.

Although OPEC often refers to “price stabilization” as its mission, in practice it is an illusory goal. The real interest of the cartel is to allow the market to move from revival to sale. As prices rise, the “monopoly” benefits from higher revenues but loses market share from higher-cost competing producers who already have an incentive to invest in new capacity.

However, their reaction raises production costs and makes their investments less efficient, thus making them vulnerable to sell-offs. Sooner or later, the dominant monopoly regains control, increasing its output, dropping prices. The steeper the drop, the better.

Usually, some shock is required for the dominant monopoly to go into sales mode. In the late 1990s, the catalyst was a shock in demand due to the Asian financial crisis. During the last collapse of the oil market in 2014, it was the shock of shale oil supplies. For a while, the model showed, the market was waiting for the right signal. The coronavirus provided it.

The decline is known, but its steepness is unprecedented. The impact of the coronavirus on demand is so devastating that it gives Russia and Saudi Arabia a unique chance to test the limits of global storage capacity.

The more it fills up, the more oil prices will tend to zero. When and if storage capacity is full, oil prices will turn negative. With current trends, this can happen within months, if not weeks.

Unlike the collapse of the oil market in 2014, low-cost oil is now unable to stimulate demand and economic activity, which has been curtailed for reasons of public health and goes straight into storage. Satellite measurements by Kayrros show that global crude oil reserves have increased by more than 100 million barrels in the last month alone to 63% of designated capacity.

The proliferation of coronavirus measures accelerates growth. No one knows for sure the actual level of maximum operational capacity, as it has never been tested – perhaps 80% of the designations. We will probably find out soon.

Given the amount of pre-planning required to lift production, one would expect Saudi supplies to decline with an increase in supply from the kingdom, at least initially. But they have jumped since the beginning of the price war.

This indicates that the oil ministers of Russia and Saudi Arabia entered their court meeting earlier this month fully prepared for the jump in supplies. The fact that Saudi Arabia and Kuwait recently settled an old dispute that allowed them to restart common oil fields that have long been inactive.

The sale will hurt manufacturers everywhere but will bring long-term benefits to Riyadh and Moscow. With their low costs and huge financial reserves, both sides can more successfully withstand the loss of oil revenues than most other producers. Others are already on edge. Sanctions-stricken Iran is an example of this.

However, the real reward for OPEC is to attract shale producers to the cause. It suddenly seems possible. Former critics of the cartel, the United States is now turning into an unexpected adherent.

Just last year, US lawmakers removed the old NOPEC bill again, but now a group of US oil senators is asking for production cuts.

A member of the Texas Railroad Commission, which managed supplies prior to OPEC, is now talking to a cartel for joint production purposes, talking with the blessing of shale companies.

Washington officials are taking action on Riyadh for a deal. The International Energy Agency set up in 1974 as a group of oil importers but whose expanded membership now includes some of the world’s largest producers, not least the US itself, scourges Moscow and Riyadh for their “irresponsibility” in eliminating oil. production restrictions.

Game theory shows how peripheral competitors passively take advantage of OPEC supply cuts while they last. However, since becoming the world’s leading manufacturer, the US has found that being a free rider may no longer be an option.

According to game theory, their market interests practically coincide with those of Russia and Saudi Arabia. The latter, threatening to open the faucets, could force the United States to join their club.

Current prices are volatile. When the storm passes, the oil landscape will change. The Shale Revolution allowed Washington to use oil as a foreign policy tool. Oil dominance, however, now established by the United States, is a double-edged sword.