OPEC: Are we going to see a Saudi change of heart?
What do you do when you your carefully crafted plan simply doesn't pay off? Do you abandon it, cut your losses and risk losing face? Or hold on to it, risking even further economic pain?
Ali bin Ibrahim Al-Naimi, the oil minister of Saudi Arabia, must be pondering that very question ahead of the December meeting of the Organisation of Petroleum Producing Countries (OPEC).
Exactly one year ago, Saudi Arabia, OPEC's biggest producer, caused one of the biggest upheavals in the oil markets. At the 2014 OPEC meeting, it blocked a cut in output, choose to defend its market share in the oil market instead of defending the price in the face of persistent oversupply in the market. Effectively, its aim was to push out the highest cost producers and hope for prices to recover once supply falls. Basic Economics 101.
The following 12 months didn't exactly go according to Saudi Arabia's plan -- or, for that matter, the economic textbook. Brent crude prices plummeted by 45 percent as US shale production didn't fall as quickly as anticipated and global oil demand stayed weak. And that slump itself was no smooth ride. Volatility was the overriding theme of the year in oil. Many who had called the bottom in March rejoiced in April when prices rallied by 21 percent , only to see those gains evaporate again in the following months.
One year after - is oil swing producer Saudi Arabia calling it quits and retreating from its risky strategy?
Some comments last week seemed to indicate just that when a Saudi cabinet briefing said the "Cabinet stressed the Kingdom's role in the stability of the oil market, its constant readiness and continuing pursuit to cooperate with all oil producing and exporting countries."
The oil price rallied more than 3 percent on these bullish comments.
However, as Deshpande Abhishek, Natixis' Oil and Gas analyst wrote last week: "We still believe if Saudi Arabia wants it strategy that it took one year ago to work, it is unlikely to give up now when they are seeing the impact of low oil on investments in non-opec and even OPEC now. It will be almost pointless to take a complete U-turn on the strategy now when it is showing signs of its impact on oil production elsewhere."
Petromatrix, an oil research firm in Switzerland strikes a more nuanced tone in a note last week stating that, while the cabinet's comments cannot be viewed as a sign that a production cut is imminent, it does signal a slight shift in tone on part of the Saudis: "We are approaching the OPEC meeting with an open mind as we consider the Saudi November 2014 policy as not working and in an impasse. After the latest Saudi cabinet statement we maintain our (open-minded) approach to the Dec 4 meeting"
Yet, the pros of holding on the drastic policy of defending market share seem to outweigh its cons.
First and foremost, it is just a matter of time before the Saudi strategy will show through in the form of lower production elsewhere and higher prices. The simple dynamics of supply and demand will produce an equilibrium at some point. Patience is a virtue here. More and more producers find it uneconomical to produce oil at these prices. Some have gone bankrupt, some have merged. More market cleansing is in the offing.Maybe not 2015, but 2016 should show more drastic results.
Secondly, I simply don't see how Saudi Arabia, as the kingpin of OPEC, is willing to risk losing face and renege on its strategy. The signal it would send to its fellow OPEC and non-OPEC members would be disastrous. It would equate to Saudi Arabia saying:" Sorry guys, the weak oil price is really killing our our budget (in fact it is, but the kingdom would never openly acknowledge that) and we got it completeley wrong - market forces don't drive the oil price anymore.Good luck to everyone else out there. We give up"
There is a chance this train of thought is flawed and the oil price would actually rally sustainably were the Saudis to let go of their policy. In that case, Saudi Arabia still faces a huge hit to its credibility and might see its standing within OPEC weakened and questions.
Stick to your plan, and wait out the rough ride. The most efficient producers will soon emerge. And until prices recover, the oil consuming nations will get the benefit of an extended tax cut.