The collapse in the price of oil in the latter half of 2014 was as dramatic as it was unexpected. In June 2014, with global prices steadily north of $110 a barrel, Alex Salmond, the then First Minister of Scotland and leader of the separatist Scottish National Party, infamously based the case for Scottish independence on the belief that North Sea oil would fund the country, a belief based on price predictions of around $113 a barrel. Then prices tumbled. By December 2014 oil prices had dropped to $70 a barrel.
The causes for this collapse have been well publicised. Increasing oil production within the US was ignited by an explosion of fracking contracts. The shale revolution saw the US overtake Saudi Arabia as the biggest oil producer in 2014. Increasing supplies were met with waning demand, most often attributed to the lethargic world economy characterised by decreasing growth in China and underwhelming recovery amongst European economies. As the US began to establish a significant percentage of market share, a threatened Saudi Arabia, for so long the kingpin of the oil market, decided to flood the market. The Kingdom convinced the 12 OPEC members to commit to producing 30 million barrels per day (bpd) in the face of falling prices. It seemed economically illogical, yet rig numbers amongst the cartel reached a record high. Saudi Arabia accelerated the fall in oil price to squeeze all producers, confident that it was best placed to survive. OPEC oil is the cheapest to produce, breaking even at $10 a barrel. Tight oil (shale), by comparison, breaks even at around $75 a barrel. Yet the squeeze did not stop the growth of American shale production and prices rallied by 45% in early 2015.
Faced with this rally, Saudi Arabia remained resolute and continued to produce high quantities of oil. In May 2015, Saudi production was 25,000 bpd higher than in April and overall OPEC produced a million barrels more than its 30 million bpd target. US production finally began to suffer. March production fell short of April drilling reports by 36,000 barrels per day and July production is predicted to fall by 91,000 bpd from current June figures. Falling US supply should logically lead to an increase in global prices, but its decline was easily compensated for by increased OPEC production which succeeded in squeezing the American market share. The price rally also faltered, with global prices currently resting at around $60 a barrel.
It is wrong to categorise Saudi Arabia’s actions as a political play, for the target of the Saudi flood is not the Obama administration. The Kingdom is wary of Iranian ambition, increasing IS-sponsored violence within its country and a retreating American presence within the region. Antagonising the USA is not a tactically astute decision given the security threats that border Saudi Arabia and the increasing dialogue between the Israelis and the Saudis illustrates the severity of these mutual fears. Instead, manufacturing low prices was a calculated attack on the investment banks who dared to challenge the Kingdom’s market dominance by investing in the US shale revolution. It is also an economic decision based on preserving long-term demand by stimulating the world economy with low oil prices.
Advances in green energy, climate change fears, and a more efficient global economy which is burning less oil burnt per unit of GDP have all fuelled Saudi concerns that demand may soon peak. As a rentier state dependent on oil revenues, the Kingdom needs to maintain and prolong global demand. Its actions have ensured that the world has become drunk on cheap oil. Demand is predicted to rise to a record 95 million bpd in the final quarter of 2015 and Saudi Arabia has managed to maintain a market share that will reap substantial reward from this growth.
Analysts have highlighted a number of factors that could see the price of oil change, but it is unlikely that these would profoundly affect the overall market. Ongoing unrest affecting production in Libya and Iraq was touted as a potential cause of a price rise. Yet Libyan production has increased and Iraqi production hit a record high this May. An impending agreement in the Iranian nuclear negotiations could see the release of Iranian oil onto the market. Some 40 million barrels of Iranian oil sit on Iranian tankers awaiting the termination of trade sanctions that a nuclear agreement could bring. Yet this is likely to be nothing more than an adrenalin shot to the overall market pattern, with Iran unlikely to develop a significant increase in output within the next year. Instead, the threat to Saudi Arabia may be itself.
Functioning at high levels of production, and heading into the months where OPEC states must divert more of its oil to keep their cities habitable in the summer sun, Saudi Arabia has drastically reduced its capacity to react to changes in oil prices. Spare capacity amongst OPEC states may shrink to just 1.7 million bpd, leaving the cartel less able to react to surges in demand. Saudi Arabia has succeeded in maintaining its market dominance, yet the Kingdom is now vulnerable to growing global demand; demand that they themselves initiated through low prices. China’s economic growth did slow through 2014 and into the first quarter of 2015, but still remains around 7%. India’s growth rate is expected to exceed China’s, reaching 7.5% this year. Even America, with lower growth rates, is consuming more oil, with cheap fuel leading Americans to drive more miles than ever before. Together these three economies have contributed nearly 80% to the world’s growth in 2015. Their continued growth, alongside the potential for greater growth amongst countries where economic results remain sluggish, will increase demand.
Added to the current geo-political threats to supply such as Middle Eastern security and increasing Russian sanctions and the potential for future prices to rise is clear. In placing all of their cards on the table, Saudi Arabia may not have the resources required to once again keep prices low. The increase in price would reinvigorate US shale production and Saudi Arabia’s market dominance would be once again challenged. Yet this time its ability to fight back would be greatly diminished. The reintroduction of Iranian oil, once the second largest OPEC contributor, could help the cartel maintain its market share. However the increasing hostility between Tehran and Riyadh would curtail Saudi Arabia’s ability to dictate production levels as it has over the last year. Oil prices are stabilising, but for the Kingdom, the stakes are being raised.
About the Author
Tom Walpole is currently studying Arabic and Middle East Studies at the Institute for Arabic and Islamic Studies at Exeter University. During his degree, Tom lived in Cairo and has focused his studies on security policy and Islamist movements within the Middle East. Tom is also alumnus of the European Youth Parliament and has an interest in researching the potential role of the European Union in Foreign Affairs.
Cover image ‘Opec Headquarters in Vienna‘ by alex.ch