When OPEC met on November 27, it was clear going in that
some nations wanted to reach a deal to prop up price. But it was clear coming out that others wanted nothing of
the sort.
Saudi Arabia blocked
the motion to cut OPEC production quotas in order to prevent prices from
falling further. The big question
is why.
To answer this, there
are three more specific questions we should examine: Who proposed the
production cuts? What affect would
continued low prices have on Saudi Arabia? And who would be helped and who would be hurt by those
prices?
First: Who proposed
the production cuts?
The question of who proposed the motion production cuts
seems unimportant because it’s such an easy answer. But anyone who looks into the workings of bureaucracy knows
that who proposes an idea is just as important as what is in it. Thank you, politics. The answer here is Venezuela. This is only meaningful insomuch as it
was not Iran that made the motion.
Iran and Saudi Arabia are at such odds that the Saudis may decline to
sign onto an agreement solely on the basis of Iranian authorship. Since it was a more benign (at least
from the Saudi perspective) Venezuela delivering the motion, this was not an
issue. And since Saudi Arabia and
Iran have voted in the same direction before when a third party authored the
bill, there is no reason to believe that Iran’s support made a difference in
the Saudi’s veto.
Second: What affect
would continued low prices have on Saudi Arabia?
What affect low prices would have on Saudi Arabia is a
complex issue, mostly because it depends on whether we examine the short term,
medium-term, or long-term. Looking
through these three lenses provides a distinctly different picture.
In the short term, all oil producers would lose revenue,
however Saudi Arabia has a sovereign wealth fund consisting of over $750
billion. Considering this is over
two-and-a-half times its revenue from oil in 2013 ($274 billion), it has the
cushion to sustain a 40% revenue cut for nearly seven years without having to
make any fiscal adjustments (of course it would adjust anyway, the math is just
to prove a point). So needless to
say, in the short-term, Saudi Arabia would feel no pressure.
In the medium term Saudi Arabia might see might benefit from
some US shale producers ceasing production or even going bankrupt. This however, would not be a gain in
market share, but rather simply maintaining its current market share as many of
these producers have yet to fully ramp up production. It should be seen more as an insurance policy rather than a
direct boost. The Saudis would
also be forced to make some fiscal adjustments. They would need to reduce spending, which is largely used to
placate the population, so as not to deplete their wealth fund too much or too
rapidly. This may not be desirable
as a reduction in oil rents to the public may cause unrest.
Long term effects can be difficult to predict but suffice it
to say that no oil producer would like them, even Saudi Arabia. The Saudis would have to extensively
rework their fiscal plans to use around half as much money they currently do,
which would almost certainly lead to civil unrest.
Third: Who would be
helped and who would be hurt by low prices?
The winners are easy to point to. They are the oil consumers of the world. The US, Europe, China, and anyone else
that burns more of the black stuff than they pump out.
The losers aren’t hard to identify either. Struggling nations that depend on oil
exports are the victims here.
Venezuela, Libya, Algeria, Iraq, and most importantly Iran and Russia.
It is easy to understand why Saudi Arabia would want to hurt
Iran. They are regional rivals with
opposing political alliances, mostly due to the Sunni/Shia divide. Iran also funds, arms, and otherwise
supports militant Shia groups like Hezbollah and the Houthis that threaten the
Saudis’ regional influence. Defunding
Iran’s regional exploits also reduces their influence in states that are or may
be up for grabs in the future like Iraq and Syria.
Russia is also understandably disliked by Saudi Arabia. Aside from Putin’s aggression against
Muslims in Central Asian states he, like Iran, also supports Assad in
Syria. Since the Saudis are
vehemently against the Syrian Assad regime, weakening any support to it is a
bonus.
Since private industry responds to price incentives, prices
would have to stay low forever to keep American shale producers out of the
game. Some shale oil firms would
go under, but not all of them would fail because of unprofitable oil fields. Many are highly leveraged and simply
wouldn’t make enough profit to pay back their loans. Any of these fields that were still profitable would be
bought by more efficient firms or super majors flush with cash. To keep American shale companies out of
the market, prices would have to stay low forever, not just long enough to put
one wave of firms out of business.
The Answer to the Big
Question:
So while the medium term benefit to Saudi Arabia of stunting
some of the American shale producers has led some to conclude that these firms
are the target of the Saudi decision to allow prices to tank, this has the
problem of seeing the interactions through only an American (or perhaps broader
Western) perspective.
The much simpler, and thus much more reliable answer lies
somewhere between economics and regional politics. Saudi Arabia is likely letting the market reach an
equilibrium on its own, before deciding how much effort to put forth to manage
it. It is costly and futile to
fight the market over the long term, but it is easier to adjust to its
long-term trends and then manage it in the short term. Saudi Arabia is watching the market
capitulate following the structural change of increased supply.
The economics provide a bonus to Saudi Arabia in the
struggle for regional influence.
Since low prices are of no immediate concern for itself, Saudi Arabia
blocked production cuts so its regional rivals would feel the pain.
In short, the Saudis are letting the price fall because it’s
economically easier, and politically convenient.
No comments:
Post a Comment