Opec’s most influential member cannot be taken for granted
The market has never seen anything like this before. The rout in 2008-09 was arguably more dramatic, but led by factors outside of the oil market. It was a result of a financial crisis and a sharp contraction in economic growth, which sapped demand for oil.
But this time it is different and not just because of the relative scale of price moves. The 2014 sell-off originated in the oil market: first from rising inventories as demand weakened and unplanned outages eased; and then when Opec — effectively Saudi Arabia — decided not to intervene and let market forces rule.
One of the reasons Saudi Arabia relinquished its role as a swing producer is precisely because of these differences — in 2008, external factors caused the drop in demand, which Opec then took action to correct. This time around, the problems came from within.
Production cuts by Saudi Arabia to shore up prices would therefore only result in the kingdom losing market share given the inability and unwillingness (for various reasons such as lack of revenues or high social spending) of other Opec and non-Opec countries to reduce output.
Inevitably, the decision by Opec to “roll over” the existing 30m barrel a day production quota at its November meeting revived old debates about its relevance and importance in the market, especially in light of the growth in US tight oil, or shale output.But these exchanges usually ignore one simple point. The decision to not intervene is a brave one given that it signals a departure from what economic theory would suggest an oil producer should focus on — revenues.
Saudi Arabia is giving up billions of dollars of revenues in the short term and running a $39bn budget deficit in 2015, in an effort to retain market share. It is betting a period of lower prices (which it can withstand given plentiful foreign exchange reserves) will shake out some high cost producers....MORE