Riyadh bides its time

23 October 2014

With massive cash reserves to fall back on, the kingdom is in no hurry to exert its influence on oil prices

Oil-exporting countries around the world waiting for Saudi Arabia to revive its role as the global swing producer may be left disappointed.

With the Brent crude price plunging below $90 a barrel in mid-October, Riyadh’s decision to maintain high production to compete for market share signals a change of policy in the corridors of power that has proved controversial within the kingdom and among fellow members of oil producers’ group Opec.

The assumption that Saudi Arabia, the world’s largest oil exporter, has the will to sacrifice export volumes to regulate the market is no longer viable, but, under the current supply/demand environment, it is also questionable whether Riyadh still has the ability to assert its authority on prices.

Internal conflict

The Oil Ministry’s move to lower the official crude price into Asia at the start of October appears to be creating divisions among business leaders in Saudi Arabia. Kingdom Holdings’ CEO Prince Alwaleed bin Talal bin Abdulaziz al-Saud launched a public broadside against Oil Minister Ali bin Ibrahim al-Naimi for allowing crude prices to fall.

In a letter addressed to ministers, posted by the prince on his personal website, Alwaleed expressed his “astonishment” at comments made by Al-Naimi playing down the impact of lower oil prices.

In the communication, the prince noted that Saudi Arabia’s budget was 90 per cent dependent on oil revenues and underplaying its importance was a “catastrophe that cannot go unmentioned”.

The prince, who holds significant stakes in a range of foreign firms including the US’ Citigroup, has been outspoken in the past about Riyadh’s oil policy. In 2013, he warned that the rise of shale oil production in the US was a threat to the kingdom’s economic stability.

Al-Naimi has repeatedly said in recent years that a price of $100 a barrel is acceptable for producing countries and consumers. But recent events suggest the kingdom is now happy for the price to remain below $90, and perhaps as low as $80 for at least the coming year.

Farouq Soussa, chief economist for the Middle East at Citigroup Global Markets, believes Riyadh does not consider it a change in policy to settle for lower prices, saying its stance has never explicitly been to target the price of oil, but to ensure the market remains appropriately supplied. “[The government] has, in the past, made comments regarding what it thought was a fair price, but has also argued that deviations from this reflect factors other than physical supply and demand conditions,” says Soussa.

Saudi Arabia… will dig its heels in and look for others to share the pain

Peter Stewart, Interfax Energy

“The ‘fair’ price they indicated has crept up from $80 a barrel a couple of years ago to $100 more recently. But that was when the demand outlook was stronger and the supply outlook was weaker. Now that is no longer the case, they seem to be signalling that the new ‘fair’ price of oil is lower.”

Saudi Arabia, as the most influential country in Opec, appears to have rebuffed calls for an emergency meeting of the 12-member group. Venezuela’s foreign minister, Rafael Ramirez, who called for the meeting, said “certain countries are overproducing to the tune of 2 million barrels [a day]”. Although he did not specify which, Saudi Arabia is the only country realistically capable of cutting output by this level. The kingdom produced record crude volumes of 9.76 million barrels a day (b/d) in 2012 and maintained historically high production last year of 9.64 million b/d.

Iran powerless

Iran, which has a reputation as one of Opec’s hawkish members on production cuts, has backed down on calls for emergency action by the group.

Oil Minister Bijan Zanganeh surprised many when, on 8 October, he reversed his previous September position and sent Brent prices tumbling further. President Hassan Rouhani had told Zanganeh to use the “oil diplomacy tool” to prevent further price erosion, according to the Iranian oil ministry website Shana. A year of sanctions has also weakened the Islamic Republic’s ability to produce and export more oil, leaving it a relatively powerless player within Opec.

“The issue for Saudi Arabia is that they don’t want to cut production and find the price doesn’t budge because US oil production keeps rising,” says Peter Stewart, chief energy analyst at London-based energy intelligence firm Interfax Energy. “Saudi Arabia is better-placed than some other Opec members to withstand a price drop, so it will dig its heels in and look for others to share the pain.”

The crude price has now fallen below the level required by many oil-reliant economies in the Middle East to balance their state budget.

The average fiscal breakeven oil price in the GCC is $85 a barrel, but varies significantly by member. The Washington-based IMF estimates Saudi Arabia’s fiscal breakeven price for 2014 at $86.1 a barrel, rising to $90.7 a barrel in 2015.

The US’ Bank of America Merrill Lynch, in its 17 October global economic review, said it would take a “marked and sustained drop in oil prices” for a revision in near-term GCC spending plans, despite the notable increase in oil fiscal breakeven prices in recent years. Record state budgets were announced this year, with increased funding for social sectors such as education, health and housing. Many governments have boosted spending to help maintain stability in the wake of the 2011 uprisings. The bank estimates that future Opec cuts could have a 0.5 percentage point drag on economic growth in Saudi Arabia, but notes the kingdom has significant cash reserves to finance deficits.

“Saudi Arabia has consistently argued that high oil prices are not good for business,” says Soussa. “When prices rise due to strong demand, then Riyadh is happy to accommodate and cash in. But in a low demand environment, I think their preference is for lower prices to revive demand.”

Recovery from the 2009 financial crash has been slow in major oil-consuming countries such as Japan and the eurozone economies, eroding global demand for crude.

If oil prices continue below $90 for the next month, tensions will increase in the run-up to the Opec meeting on 27 November in Vienna, when the group will set its production quotas. Opec would like to regain authority over oil prices, but there are major divides among its members over the urgency of production cuts to change the dynamics of the market.

While major oil exporters in the GCC such as Saudi Arabia, the UAE and Kuwait can withstand a period of lower prices by falling back on cash reserves, many other Opec exporters are likely to become uneasy with the situation.

Iran, which is struggling under years of international sanctions against its energy, shipping and financial sectors, has a fiscal breakeven oil price of $130.5 a barrel in 2014, according to the IMF. Germany’s Deutsche Bank estimates that Venezuela needs an average oil price of $121 a barrel this year to balance its books, while Nigeria has a breakeven price of $118.8.

Among the many theories behind Saudi Arabia’s inaction over oil prices are suggestions that Riyadh is working with its allies in Washington to weaken the economies of political rivals Iran and Russia – two powers subject to international sanctions and heavily reliant on oil revenues to balance their books. Other commentators have presented Riyadh’s position as a game of chicken with the US’ unconventional oil sector, which is providing much of the global capacity growth amid an oversupplied market. US shale producers have higher operating costs than their Gulf counterparts and at lower prices could be forced to roll back output as profits margins shrink.

In June, the Paris-based International Energy Agency estimated that the US had overtaken Saudi Arabia as the world’s biggest producer of oil and natural gas liquids, with daily output exceeding 11 million b/d.

The long game

Citigroup’s Soussa argues that Riyadh’s stance on oil prices can be considered normal for a period of slow demand and that the kingdom’s leaders are playing the long game to stimulate recovery. “I think Saudi Arabia believes price movements don’t reflect current physical supply and demand conditions, but a host of factors including perceived long-term trends…  so changing current production levels are not going to make a difference,” he says. “But if a low price results in a downgrade of future supply expectations as high-cost projects are priced out of the market, then the oil price should have a floor that reflects this.”

No major production decisions are likely to be made until the November Opec meeting, when the more oil-dependent governments will try to convince Riyadh to help reassert the oil group’s authority over the market, if the price stays at its current low level.

“It’s impossible to say at this stage what the result of the meeting will be, but it will not be an easy one behind the scenes,” says Stewart.

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