House of Saud Oil-Price Drop

Plenty of speculation the last several days as to why the Saudis seem to support the price drop in oil, which has gone from a six-month high of $115 a barrel to $83.

One school of thought is that the Saudis want to make sure that U.S. shale oil production is not expanded. The closer the price-per barrel reaches the $60 mark, the more Texas and North Dakota oil become a money loser.

Another school of thought, one expressed by Thomas Friedman in a column yesterday, "A Pump War?," is that the Saudis are seeking to damage the Russia-Iran-Syria axis:

The price drop is the result of economic slowdowns in Europe and China, combined with the United States becoming one of the world’s biggest oil producers — thanks to new technologies enabling the extraction of large amounts of “tight oil” from shale — combined with America starting to make exceptions and allowing some of its newfound oil products to be exported, combined with Saudi Arabia refusing to cut back its production to keep prices higher, but choosing instead to maintain its market share against other OPEC producers. The net result has been to make life difficult for Russia and Iran, at a time when Saudi Arabia and America are confronting both of them in a proxy war in Syria. This is business, but it also has the feel of war by other means: oil. 

The Russians have noticed. How could they not? They’ve seen this play before. The Russian newspaper Pravda published an article on April 3 with the headline, “Obama Wants Saudi Arabia to Destroy Russian Economy.” It said: “There is a precedent [for] such joint action that caused the collapse of the U.S.S.R. In 1985, the Kingdom dramatically increased oil production from 2 million to 10 million barrels per day, dropping the price from $32 to $10 per barrel. [The] U.S.S.R. began selling some batches at an even lower price, about $6 per barrel. Saudi Arabia [did not lose] anything, because when prices fell by 3.5 times [Saudi] production increased fivefold. The planned economy of the Soviet Union was not able to cope with falling export revenues, and this was one of the reasons for the collapse of the U.S.S.R.” 

Indeed, the late Yegor Gaidar, who between 1991 and 1994 was Russia’s acting prime minister, observed in a Nov. 13, 2006, speech that: “The timeline of the collapse of the Soviet Union can be traced to Sept. 13, 1985. On this date, Sheikh Ahmed Zaki Yamani, the minister of oil of Saudi Arabia, declared that the monarchy had decided to alter its oil policy radically. The Saudis stopped protecting oil prices. ... During the next six months, oil production in Saudi Arabia increased fourfold, while oil prices collapsed. ... The Soviet Union lost approximately $20 billion per year, money without which the country simply could not survive.”

Neither Moscow nor Tehran will collapse tomorrow. And if oil prices fall below $70 you will see a drop in U.S. production, as some exploration won’t be cost effective, and prices could firm up. But have no doubt, this price falloff serves U.S. and Saudi strategic interests and it harms Russia and Iran. Oil export revenues account for about 60 percent of Iran’s government revenues and more than half of Russia’s. 

The price decline is no accident. In an Oct. 3 article in The Times, Stanley Reed noted that the sharp drop in oil prices “was seen as a response to Saudi Arabia’s signaling ... to the markets that it was more interested in maintaining market share than in defending prices. Saudi Aramco, the national oil company, stunned markets by announcing that it was cutting prices by about $1 a barrel to Asia, the crucial growth market for the Persian Gulf producers, as well as by 40 cents a barrel to the United States.” The Times also noted that with America now producing so much more oil and gas, “net oil imports to the United States have fallen since 2007 by 8.7 million barrels a day, ‘roughly equivalent to total Saudi and Nigerian exports,’ according to a recent Citigroup report.”

The last paragraph points to a purely economic rationale for the Saudis keeping oil prices low: they want to maintain their market share. Reduced demand is with us to stay for the foreseeable future. Europe is mired in recession; a stock market panic in the U.S. could halt the anemic Obama recovery; Ebola will have a damaging effect on the global economy; and the Green energy revolution will continue to sap demand for oil in industrialized nations.

The Saudis have read the tea leaves. Decreased demand for petroleum is in the future. They're making their play now to keep their spot as king of the hill.