Money and politics drive Saudi oil plan

Low prices hurt Iran and Russia — and protect Riyadh’s market share

WORLD oil prices have plummeted by close to 50% over the past year, triggered by weaker economic growth in China and Europe. Yet production has remained consistently high.

The decision by the Organisation of the Petroleum Exporting Countries not to cut output will hurt the economies of Russia and Iran, and deal a blow to shale oil production in the US.

This price drop quite simply feeds a universal economic war.

Saudi Arabia is applying a highly predatory pricing strategy, which boils down to reducing the market share of its competitors and fighting a proxy war with its enemies.

The Saudis and their Gulf allies have decided not to sacrifice their own market share to bridge the price gap.

Eminent economists believe the cartel has the capability to curb production sharply, but doing so would mainly benefit countries the Saudis despise, such as Iran and Russia.

Conversely, the fall of the oil price below $50 a barrel has everything to do with increased US production threatening Saudi Arabia’s standing as the pre-eminent oil-producing nation.

The US shale oil success creates a problem for crude producers in the Gulf. The problem is exacerbated by the US stepping up its output, which sets the stage for a battle for market share between Opec and non-Opec countries.

If Opec cut production, it could push the oil price up to $70 or $80 a barrel, and the decision not to do so was an attempt to hurt the US market.

If the Saudis had opted to cut production and shore up prices, they would have been perceived as subsidising US production. Equally, lower prices could help to drive some of the higher-cost US shale oil production out of the market.

The consensus is that a price war might reduce the viability of some future US shale oil projects due to high production costs, easing competitive pressures on Opec over the long term.

The winner of this economic battle is Saudi Arabia, which is gradually moving towards its main goal — to oust US shale oil from the market and make US oil sands production unprofitable while strengthening its own position. If US shale projects shut down, Saudi Arabia’s share of the market will be reinstated.

A lower oil price will not negatively affect Gulf producers in Saudi Arabia, Qatar, Kuwait and the United Arab Emirates; these countries can sustain lower prices because they have accumulated trillions of dollars in buffer funds.

It appears that Saudi Arabia is applying a valuable principle from its oil-war strategy book.

In 1973, the then Egyptian president Anwar Sadat persuaded Saudi Arabia to cut production, raise prices and embargo oil exports with the goal of punishing the US for supporting Israel against the Arab states. This plan worked; the oil price quadrupled.

In 1986, Saudi Arabia flooded the market with crude to punish cartel members that were failing to stay within their agreed quotas and were grabbing market share from it.

And in 1990 the Saudis manoeuvred production to deliberately send prices into decline as a way of cutting off Russia.

The current oil price slump has dual economic and political foundations.

Saudi Arabia, the world’s largest oil exporter and producer, is using it to achieve its foreign policy objectives.

Both the Saudis and the Americans are fighting a proxy war against Iran in Syria. The Saudis have an ulterior motive in playing “chicken” with the oil trade. Opec’s decision not to cut output will hurt the economies of Russia and Iran, which support Bashar al-Assad’s regime in the Syrian civil war.

Since Saudi Arabia and Qatar began arming many of the Syrian rebels, Iran and to a lesser extent Russia have provided weapons and funding to keep Assad in power.

The low oil price and sanctions against Russia could force it to abandon its support of Assad, whom the Saudis would like to see ousted.

The timing of this price drop is also designed to keep Iran at the nuclear negotiating table by crippling its economy and that of its nuclear supplier, Russia.

For Iran, the sharp price drop means it will not be able to sustain its government-run social programmes. Tehran has learnt to live with Western sanctions, but the oil trade is its lifeline and for it to balance the books, oil has to sell at between $135 and $140 a barrel.

The Saudis believe they can no longer rely on the US to contain what they see as Tehran’s imminent nuclear threat, so they are out to use their most effective weapon to do what lukewarm sanctions could not.

But there is little evidence that authoritarian regimes such as Russia and Iran will change their positions under economic pressure.

The worst-case scenario, according to political analysts, is that the Saudi policy could backfire, making Russia and especially Iran more intransigent in countering Saudi influence in the Middle East.

Tshazibana is director of the Corporate Leadership Development Institute

Sandile Tshazibana

The US shale oil success creates a problem for crude producers in the Gulf