Thursday, December 18, 2014

Who Is In the Saudi Crosshairs… the US or Regional Rivals?

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: