Gas for $2.50 a Gallon — Thanks, Sheiks!
WHY YOU SHOULD CARE
Saudi Arabia’s oil strategy will make life cheaper for consumers everywhere, even if producers squirm.
With $2.50-a-gallon gas prices having come our way, we have the Saudis to thank.
Oil prices are plunging these days — in fact, they hit a five-year low this week — and it’s thanks in no small part to Saudi inaction, a new strategy of doing nothing. For anyone who follows the big oil biz, the reason isn’t entirely surprising: Saudi Arabia has lost its once-infamous grip on oil prices. But now, the white flag is really out. And the result? Today, $2.45 a gallon is average throughout the land at U.S. gas stations.
For nearly three decades, Saudi Arabia has been the “swing producer” as the biggest player in the OPEC oil cartel. When oil markets had too much supply, the Saudis cut back production — currently at 9.73 million barrels per day — and exports. When oil markets were running dry, they would swing the other way and boost output. But “quite clearly, they don’t seem to be swinging now,” Antoine Halff, head of the International Energy Agency’s oil market research, tells OZY. Instead, they’re just keeping the flow steady like almost every other oil producer.
It’s been decades since Saudi Arabia used oil as a weapon, as the nation did in the 1970s to drive up prices. Or when, as in 1986, it flooded the market and drove oil down to giveaway prices under $10 a barrel, delivering a blow to high-cost producers in the North Sea and Texas.
The old pricing system buckled under the pressure.
But the Saudis may be revisiting history — though this time it’s more like farce than tragedy.
Let’s face it: OPEC’s not much of a cartel anymore. Saudi Arabia lost its distinction as the world’s biggest oil producer to Russia in 2009. Then the U.S. shale revolution knocked the Saudis back to third place. Today, the U.S. is the world’s biggest oil and gas producer. But Saudi Arabia is still the world’s biggest exporter, and until last year, it looked like it was happy to continue playing the role of swing producer.
“Libya went down in 2011, and Saudi increased production,” points out Francisco Blanch, commodity and derivatives strategist at Bank of America Merrill Lynch. But after a cycle in which the Saudis decreased and then increased production as Libyan exports went up and down, they’ve kept production up in the face of the latest surge of Libyan output. “So I think there’s a clear change in policy on the Saudi front,” he says.
So what game are they playing? “I don’t think it’s very mysterious,” says Daniel Yergin, Pulitzer Prize-winning author of The Quest: Energy, Security, and the Remaking of the Modern World. “The old pricing system buckled under the pressure,” he says, noting that the Saudis are “reacting to the situation, rather than fomenting it,” in a bid to retain market share.
So what’s changed? U.S. oil production is up 70 percent from 2008, and net imports as a share of consumption have dropped from 60 to less than 30 percent. In the past year alone, global oil production rose by 2.8 million barrels a day to 93.8 million barrels per day in September.
Meanwhile, the global economy is suffering a slowdown — everywhere from the eurozone to Brazil, from China to South Africa. The IEA has lowered its forecast for 2014 global demand to 92.4 million barrels per day. That’s an excess of supply over demand, which means storage tanks are filling up — and prices have nowhere to go but down. They’re now well below $60 a barrel for Texas crude.
As it turns out, the Saudis might just like it that way. That’s because they don’t want to sacrifice long-term market share by subsidizing high-cost U.S. shale production. To avoid this, they’ll probably sit tight and wait for production to go down elsewhere before making a move. “They’re changing their strategy. They’re very much changing their pricing ambitions across their markets,” Halff says.
With prices in the mid-$50 range, projects planned when oil was over $100 a barrel start to look unattractive. If investors pull out of U.S. production, it means less long-term competition for Saudi oil. Or, as Halff believes, the Saudis may just be willing to forgo the U.S. and push exports toward Asia instead. “Crude producers are fighting for market share in the one growth market — Asia,” Halff says.
There’s been speculation about geopolitical reasons the Saudis may want to keep prices down, ranging from targeting the Islamic State’s oil revenue to boosting President Obama’s political capital. It certainly doesn’t hurt that low oil prices harm its enemy, Iran, or Russia, while helping a weak global economy. But likely these factors are taking a back seat to Saudi Arabia’s primary interest: ensuring long-term income by establishing market share and discouraging high-cost production.
There’s a tendency to think they are sitting there controlling all the levers, but they aren’t.
“There are other steps the Saudis could take to curtail ISIS funding if it really wanted to,” says Graham Stock, head of emerging markets and sovereign research at London’s BlueBay Asset Management. Yergin agrees: “There’s a tendency to think they are sitting there controlling all the levers, but they aren’t.” So much for conspiracy theories. Blanch and Halff agree that the lower prices could stick around for a few years. That’s upsetting OPEC countries, like Venezuela, that are already complaining about low prices. Many cartel members struggle to break even when prices drop below $100 a barrel, much less at current rates. But few believe Saudi Arabia’s going to come out swinging at production anytime soon. Doing nothing just looks good.
This story was updated on 12/19/2014.