27.05.2014 Author: Viktor Mikhin

Can Saudi Arabia crash the oil market?

NEO COLLAGE 47.Saudi Arabia, which is currently standing together with Russia at the top of global oil exports, is ready to supply the global market with additional oil if the tensions flare between Russia and the west because of the events in Ukraine. Citing Saudi Arabian Minister of Petroleum Ali bin Ibrahim Al-Naimi, Saudi media has reported that Riyadh is ready to compensate for any oil deficits if they arise. Al-Naimi stated that “We are ready to compensate for any shortages (in the supply of oil) if they arise.” According to him, the kingdom is currently producing around 9.6 million barrels of oil per day, however, it is ready to increase this to 12.5 million. Well-informed sources also report that in April, Saudi Arabia exported 9.65 million barrels/day to the global market as compared with 9.533 million in March of this year.

Commenting about the current global oil prices, Al-Naimi called them “fair”. “$100 per barrel is a fair price for everyone, be it consumers or producers.” According to the Saudi minister, the Organization of the Petroleum Exporting Countries (OPEC) member states should make the decision to keep the existing maximum oil production threshold of 30 million barrels/day at their summit meeting in June of 2014.

Incidentally, in April of 2014, total global oil production increased up to 90.8 million barrels/day as reported in the monthly OPEC report on the condition and the future of the global oil market. Compared with March, global oil production increased by 160,000 barrels/day. At the end of April, oil production in the OPEC countries amounted to 29.593 million barrels/day, which is an increase of 130,800 barrels as compared with the previous month. It was notably Iraq which significantly increased oil production in April, by 102,100 barrels/day.

Oil market analysts point out that the military action in eastern Ukraine provoked by Kiev, which is actively supported by the west, has increased the tensions between Russia and Europe, leading to some worry about oil exports from Russia to Ukraine and Europe. Furthermore, these tragic events are keeping the prices for Brent Crude at $108/barrel after the fact that on March 3, prices soared to their annual high of $112.39. It is considered that increased oil exports from Saudi Arabia may lower prices on the global market to $100/barrel.

The previous statement by the Saudi minister invoked a fairly professional comment from the Qatari newspaper Asharq, “This can be understood as a change in the relations between Saudi Arabia and Russia. By lowering oil prices on the global market, the U.S. wants to pressure Russia through Saudi Arabia. Yet Russian President Vladimir Putin believes that Riyadh does have the ability to lower oil prices on the global market. However, he thinks that Saudi Arabia will not go that route because if oil prices plummet below $85/barrel, the Saudi economy could also face problems. Both Saudi Arabian and Russian budgets are calculated with oil prices at around the $90 mark.”

A price war on the oil market is currently very risky for OPEC countries. After all, the development of new technology (such as shale oil and gas) will very likely strategically lower oil prices in time. If prices are to be artificially lowered right now, this could plummet the market into a prolonged period of lower prices before its due time and the market would take a significant amount of time to recover. For oil exporting countries, this would certainly mean economic losses. Although the Saudi Arabian economy is a bit more resistant against price fluctuations than the Russian economy, this does not mean that it would not suffer from a price decrease. On the contrary, it could suffer greatly from a prolonged price drop.

Nevertheless, there is still the possibility that oil prices will gradually wane in the long-term, even in the mid-term, but this is not related to the foreign policy tensions between Russia and the west. This is why following a responsible economic policy and curtailing state spending in the present unstable environment becomes especially relevant for Russia.

UAE’s The National newspaper reports that five oil exporting countries in the Middle East and in North Africa could hit a budget deficit this year even if oil prices remain around the $100/barrel mark. Saudi Arabia has indicated it will shift to a more sensible fiscal policy after planning this year’s budget, which slowed the growth of spending to 4.3% as compared with 20% in the previous year. However, Bank of America Merrill Lynch has warned that the Gulf’s largest oil producer may need to undertake additional measures if the sanctions against Iran will be eased to the point where the country could accelerate oil production. The bank’s analysts wrote the following in a recent report: “Going beyond breakeven oil prices in addition to the potential return of Iranian oil to the market leads one to believe that governments should moderate growth in spending. In the midterm, the math for oil prices that break even with the budget is clearly inconsistent with politics while accounting for the fact that current budget revenue is limited by [oil] production and the weak non-oil revenue.”

Saudi Arabia’s ability to manipulate market prices currently does not hold much promise. Analysts believe that to do this, a country needs to be able to decrease and increase the volume of production painlessly both for the industry and for the economy. The kingdom has the capacity to produce an additional 3 million barrels/day, which only makes up around 3% of global production. Correspondingly, it will not be able to “flood” the market with cheap oil.

Naturally, production costs are much lower in Saudi Arabia than in the U.S. and Russia, but Riyadh has not escaped the pitfalls of the Dutch disease: the kingdom’s budget currently relies on oil prices being $90/barrel and it is only able to sustain very temporary price drops to $80/barrel. In Saudi Arabia, 85% of the budget is sustained through oil exports. Oil also makes up 90% of the country’s exports (as a comparison, this is 33% in Russia), which is why a decrease in oil revenue may lead to a foreign deficit as well as increased pressure on the exchange rate and on the gold and foreign-exchange reserves, which are also significantly lower than Russia’s.

Furthermore, Saudi Arabia is a member of OPEC and its decision to lower prices may not be understood by the other cartel members for whom lower oil prices are just as dangerous as they are for Russia. Incidentally, analysts have already calculated the “behaviour” of oil countries after 2008: if prices close in on the $80-$90 mark, the value indexes quickly turn around and swiftly increase back up.

However, head of the Oil Market Research Department at the New York Branch of Société Générale Mike Whitner believes that “Saudi Arabia will always play a key role. It is the only country that has the technical capabilities and the ability to increase or decrease oil production as necessary”. Gary Hufbauer from the Peterson Institute for International Economics in Washington points out that Saudi Arabia could partner with the States because Riyadh greatly dislikes the role that Moscow is playing in Syria.

Russian President Vladimir Putin doubts that Saudi Arabia would lower oil prices to harm Russia. It is known that the Russian budget earns about $191-$194 billion from oil and $28 billion from gas. In discussing whether it is possible to harm Russia through hydrocarbon prices, he stated, “Well, it’s possible to try”. According to the president, the only country in the world that can increase oil production to crash prices is Saudi Arabia. However, the head of state is certain that Saudi Arabia will not go through with this because it is not beneficial for the country itself. “We have good relations with Saudi Arabia. Saudi Arabia is also acting within the confines of OPEC and drastically increasing production is a fairly difficult task, they need to negotiate with everyone. Saudi Arabia’s budget has been calculated for, I think, $85-$90 per barrel, while ours has it at $90. That is, going under $85 would mean Saudi Arabia would suffer losses and it would encounter problems,” Putin clarified. He also stated that lowering oil prices from $90 to $85 per barrel would not even be critical for the Russian budget.

Furthermore, the president noted that lowering oil prices is not beneficial for the U.S. either as they are actively producing shale oil on their own territory. Crashing prices could make this sector no longer profitable, Putin stated. “And another thought: oil is quoted and sold on global markets in U.S. dollars. If prices drop then the demand for the dollar will also suddenly drop. Then the dollar will begin to lose its importance as a global currency,” President Putin warned.

Victor Mikhin, corresponding member of the Russian Academy of Natural Sciences, exclusively for the online magazine “New Eastern Outlook”.