A Game of Chicken ... With Oil - OZY | A Modern Media Company
(NYT42) JIDDAH, Saudi Arabia -- Oct. 25, 2007 -- SAUDI-UNIVERSITY -- A Saudi Aramco employee walks through the KAUST construction site in Thuwal, outside Jiddah, Saudi Arabia on Monday, Oct. 22, 2007. On a marshy peninsula 50 miles from this Red Sea port, King Abdullah of Saudi Arabia is staking $12.5 billion on a gargantuan bid to catch up with the West in science and technology. Between an oil refinery and the sea, the monarch is building from scratch a graduate research institution that will have one of the 10 largest endowments in the world, worth more than $10 billion. (Bryan Denton/The New York Times)
SourceBryan Denton/Redux

WHY YOU SHOULD CARE

This gutsy strategy could play out brilliantly — or leave both countries bleeding black gold.

By Simon Constable

Simonomics: A regular look at the global economy from a former staff columnist at The Wall Street Journal. 

In the world of oil, a little noticed but fascinating game of chicken has broken out. And the unblinking eyeballs happen to involve a guy named Putin and a prince who enjoys fast cars, all 200 of them that he supposedly owns.

Does any of this ring a bell? As some of you may have surmised, the two biggest so-called petro giants, Russia and Saudi Arabia, are locked in a battle to maintain control over the global dominance of oil that’s slowly slipping away as other forms of energy like natural gas begin to grow in importance.

Both countries produce gigantic sums of oil: 11.6 million barrels a day for Saudi Arabia, and 10.9 million for Russia, according to the U.S. Energy Information Administration, a government body that tracks this industry. That’s enough to place them second and third in the world, behind only the United States.

The two countries should slow down how much they’re tapping those oil wells. But neither can or is willing to.

And that’s where the problem begins. As anyone who’s been at the gas pumps lately has noticed, the price of oil is dropping like a heavy stone. It’s now around $43 a barrel, less than half what it was a year ago. Few commodities have fallen that quickly, and here in the U.S., the country can stomach the drop because the economy benefits from cheaper energy costs. But Saudi isn’t quite that lucky, since an estimated 80 percent of its budget relies on oil, according to the CIA World Factbook. As for Russia? Almost 70 percent of its export revenue is oil based, the EIA says.

The obvious answer when prices drop is to reduce supply. In other words, the two countries should slow down how much they’re tapping those oil wells. But here’s where it gets pretty intriguing: Neither can or is willing to.

Instead, both are continuing to sell as much oil as they possibly can, regardless of what that does to world prices, says Max Pyziur, analyst at the Energy Policy Research Foundation. There is a logic to this. They’re holding steady with their prices until they’ve secured relationships with the countries that need energy. Putin, for one, wants Russia to keep pumping 10 million barrels a day through the end of this decade, while Saudi is taking a similar approach to maintain ties with its customers, says Emily Stromquist, an analyst at research consulting Eurasia Group in London.

But how long can this go on? Quite a while, with some forecasting production cutbacks as far off as 2017. No wonder then, as Greg Priddy, an oil analyst at Eurasia Group, puts it, “The oil world is in a battle for market share.” What’s more, it helps that Russia and Saudi Arabia have government cash reserves that top $300 billion and $700 billion, respectively.

Still, it’s not hard to envision an endgame that won’t be all that pretty for these great big oil leaders. The more they both keep pumping oil and adding to the glut, the more likely they are to burn through those reserves. And that’s where the real financial pain comes in: After all, the funny thing about cash reserves is they can only be spent once.

 

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