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HewarGuest Writer – Nehad Ismail, argues it is unfair to ask the Saudis to cut production if others won’t.GUESTSM2

When oil prices skyrocket, the West blames OPEC in general, and Saudi Arabia in particular. When the price plummets, guess what? – We blame Saudi Arabia.

The OPEC oil cartel produced 31.7 million barrels a day in November, its highest output in over 3 years. Meanwhile Iran is poised to ramp up its production once sanctions are lifted next year. All this at a time when crude oil prices are trading at below $40 per barrel. Prices have dropped 70% since the summer of 2014.
In response BP and other major oil companies announced big cuts in capital investment and jobs and profits had crashed. Royal Dutch Shell said it will cut spending by £10 billion over the next 3 years. All the oil majors are in a similar position.

The collapse of prices is hurting. Historically the Saudis were always to blame when prices of oil were too high, now, with prices at their lowest since 2004, Saudi Arabia is still being blamed.

OPEC is a 12-nation cartel. It aims to manage the supply of oil in an effort to set the price on the world market in order to avoid fluctuations that might affect the economies of both producing and purchasing countries. Its influence has reduced – it now speaks for only a third of world output, down from a half 25 years ago.

Iran, Russia, Venezuela, shale oil producers in the USA, and offshore producers in the North Sea and the Gulf of Mexico blame the Saudis for pumping so much oil it reduces prices. In 2014 Reuters reported that Iran’s President Rouhani “blamed unnamed countries of plotting to bring down crude prices and said the recent slump in oil prices was not based solely on economic factors”. But is Saudi to blame?

It is clear the Saudis will stick to the policy of producing around 10m barrels per day and will not curtail production soon. The Saudi Oil Minister was quoted as saying “We may not see the 100 US$ per barrel again.”

The facts are complex. The real reasons for the slump in oil prices are weak demand in many countries, especially China, due to weaker economic growth, coupled with surging US production. Oil producing countries inside OPEC have unsuccessfully lobbied the Saudis to reduce production. Iraq, despite the war with ISIS, is still managing to produce 4m barrels per day (pd) and Russia is producing 10.5m barrels pd. In total the world produced a record 92.18 million barrels of oil pd in 2014 leaving a daily surplus in excess of 1 million barrels. Despite that, OPEC producers continued to produce around 310m barrels pd.

So, the combination of a shrinking Chinese demand and expanding US production has resulted in a big surplus which has driven down prices.

This in turn means that American shale-oil and gas producers in North Dakota and Texas are now feeling the pinch. The relatively high production costs of shale energy means that they need a price in the range of $60-$70 per barrel to be profitable and a price of under 40 US$ per barrel is catastrophic for the companies involved in shale. In contrast in Saudi Arabia it costs only a few dollars to produce a barrel of oil. Another factor is the fact that the USA stocks of crude oil are at their highest since 1982 meaning it now imports far less oil from OPEC countries.

Therefore the main winners are countries which import most of their energy needs from OPEC, consumers in Europe, Asia and the USA as well as the heavy industrial users such petro-chemical manufacturers. But the biggest losers are the producers themselves. Within OPEC, Iran and Venezuela have been hit hard. Outside OPEC, Russia, fracking companies and offshore producers suffered heavy losses. So regardless of motivations, the prospect is a reversal of the long term drain of wealth from consuming to producing nations – a significant strategic turnaround.

Saudi Arabia is not under any obligation to cut its production to help Iran, Venezuela, Russia or the US frackers. It suits Saudi Arabia if the frackers and shale oil producers are driven out of business.

What the Saudis are saying is this: Why should we sacrifice our market share just to help the high cost offshore producers and the frackers? The simple explanation may have more substance than any conspiracy theory.

We must remember OPEC production remained unchanged between 2013/2015 whilst the US increased its production by 2 million barrels pd.

At the moment, Saudi Arabia is no mood to help any competitor by cutting down production.

One final point has anyone thought of asking Russia or the USA to cut its production to help boost the prices?

Nehad Ismail


5 Comments on "Why Should Saudi Arabia Have To Cut Oil Production?"

  1. As you note, most Saudi oil is from conventional wells and is greatly less expensive to recover than offshore, enhanced recovery and fracking. Maybe of greater significance; those enhanced and offshore wells are very expensive to keep in place; they have a high maintenance cost. Capping offshore wells can be near-impossible or prohibitively expensive and mothballing the capital equipment is either hugely expensive or impossible. So, leaving aside the national interests of the producer and looking at this on a global level, it would be better to recover all the reserves from offshore, and enhanced recovery (and fracking) wells presently in production until those wells are dry and and then decommission them. Exploration could continue, of course.

    However, there are national and geopolitical considerations. Oil is probably the world’s biggest weapon of war and peace. Saudi might consider investing much of their vast dollar reserves in overseas mineral rights and petroleum companies, leaving their children and grandchildren the precious gift of easy-to-produce oil, onshore.

    Quite how they would protect their underground asset from others is quite another matter(!!) However you asked why Saudi Arabia should cut its own production and I hope I have outlined a sound answer? It could be good for the gross world economy and Saudi Arabia.

  2. Thanks David. You make some interesting and compelling points. Yes your answer is sound and makes a lot of sense. Some commentators are of the view that oil is a political weapon. Earlier this evening I was on an Arabic TV program discussing the Saudi Budget for 2016. In answering one question: “why doesn’t Saudi Arabia cut its production to help boost the prices? When I replied “Why should Saudi rescue Russia, Iran and the US Shale producers? The interviewer remarked: “then the Saudis are using the oil as a political weapon”. I said yes why not if they feel it is in their own strategic interest.

  3. Nehad, Yes, I agree — why shouldn’t Saudi use her resources for political and military posturing? Everyone else uses their resources, after all. My point about SA might doing better conserving her oil and investing in recovery under other nations’ territory comes with that huge caveat: Can she protect herself for the foreseeable future? It could be that Saudi won’t be able to shelter under the US/NATO nuclear umbrella for very long particularly if wahabism morphs into ISIL, within SA. That would be a bad thing.

  4. Thanks David. Tricky questions. No easy answers.

  5. Correction: 9th Para last line should read: 31M barrels Not 310.

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