Saudi's best bet is to crash oil price

Last Updated 20 October 2019, 16:26 IST

Julian Lee

Saudi Arabia should give up trying to manage the global crude market and return to the pump-at-will policy it briefly adopted in 2014 under its longest serving oil minister Ali Al-Naimi.

In the mercantilist world in which we now live, where decisions are based on narrow national interest, it makes no sense for the world’s lowest-cost oil producer to subsidize shale and prop up other high-cost suppliers.

Of course when it does, oil prices will crash just as they did in 1986 when the country finally abandoned fixed official selling prices. And then, in the aftermath, global investors will get in a flap about all things Saudi: the IPO of the kingdom’s state oil company, the financing required to fund a young and under-employed population, Mohammed bin Salman’s ambitious Vision 2030 plan to transform the economy away from its dependence on oil.

Despite the risks, it’s time to admit that market management is failing, even though Saudi Arabia and it “allies” say that it isn’t.

The OPEC+ agreement was meant to drain excess stockpiles in six months. But we are now approaching a fourth year of Saudi Arabia leading a global alliance of producers in trying — and failing — to push up oil prices in a sustainable way.

For a while it appeared that the cuts were having the desired effect. Inventories came down and Brent prices rose from about $45 a barrel in June 2017 to reach a high of $86 in October 2018. But they swiftly fell back towards $50 and a second round of cuts that began in January has failed to keep them above $60. Even the temporary loss of more than half of Saudi Arabia’s oil production — and most of the world’s spare capacity — in an attack on two of the kingdom’s biggest processing facilities failed to lift prices for more than a few days.

The latest data from OPEC itself — along with the International Energy Agency and the US Energy Administration — show the failure of the policy.

All three see global oil inventories building in the first half of next year in the face of what is starting to look like America’s forever trade war. The global gridlock has also prompted a reduction in forecasts for growth in oil demand this year and next. The average level of Saudi oil production in the first eight months of 2019 was the lowest since 2014 — even excluding the dip caused by the September 14 attacks. And it will have to come down further next year if the kingdom wants to continue trying to manage the market.

Meanwhile Russia, the kingdom’s leading partner in the OPEC+ group of countries that came together to manage supply, has seen its output continue to rise each year, even as it has come to dominate OPEC+ policymaking.

Saudi Arabia should let American shale drillers take the strain. After all, aren’t they the producers of the marginal barrel of crude now? As long as Saudi Arabia and its cohorts continue to restrict output and subsidise shale they are merely delaying an answer to the question.

Time for true price.

Saudi Arabia will learn to work with this over time, just as it did after 1986. And it will probably find that that price isn’t as low as the kingdom fears. Eventually, shale producers will be forced to cut back — or they won’t.

If they are forced to cut, then Saudi Arabia will get the price support it craves, without having to lower its own output. But if shale production can just keep going up and up, even in a lower-price environment, then it proves just as emphatically that the Saudi-led policy of market management is a busted flush anyway.

Will they do it? I doubt it.

Current oil minister Abdulaziz Bin Salman sees it as his job “to ensure that the oversupply doesn’t continue.” December’s OPEC and OPEC+ meetings will likely yield the promise of further output cuts and Saudi Arabia will pump even less next year in a vain attempt to prop up prices. But it would be nice to believe that they are capable of change.

(Published 20 October 2019, 14:35 IST)

Follow us on