News analysis

Saudis choose higher prices over free oil markets

RIYADH • Saudi Arabia has ended its flirtation with free oil markets.

It took the kingdom's new oil minister, Mr Khalid Al-Falih, just six months to blink, ending the country's two-year policy of pump-at-will. 

The decision at this week's meeting of the Organisation of Petroleum Exporting Countries (Opec) in Algiers to cut production was necessitated by Saudi Arabia's tattered finances.

The kingdom has the highest budget deficit among the world's 20 biggest economies, may delay its first international bond issue and now faces fresh legal uncertainty after the US Congress voted this week to allow Americans to sue the country for alleged involvement in the Sept 11, 2001, terror attacks.

"Saudi Arabia wants higher prices," said Ms Amrita Sen, chief oil analyst at consulting firm Energy Aspects in London. The consequences could be vast.

Giants such as Exxon Mobil may soon be flush enough to revive abandoned projects. The finances of cash-strapped Opec countries like Venezuela will get a boost. Russia and other independent oil-rich countries will have to decide whether to follow Saudi Arabia's lead.

The Permian Basin oil field (top) in Texas. The recent low prices tossed water on the US oil boom. The decision at the Opec meeting in Algiers (above) to cut back on production should bring higher prices.
The Permian Basin oil field in Texas. PHOTO: AGENCE FRANCE-PRESSE

The Permian Basin oil field (top) in Texas. The recent low prices tossed water on the US oil boom. The decision at the Opec meeting in Algiers (above) to cut back on production should bring higher prices.
The recent low prices tossed water on the US oil boom. The decision at the Opec meeting in Algiers (above) to cut back on production should bring higher prices. PHOTO: AGENCE FRANCE-PRESSE

CALCULATED MOVE

Saudi Arabia is betting that a small cut will pay for itself through higher oil prices and hence higher revenues.

JAMIE WEBSTER, a fellow at the Centre on Global Energy Policy at Columbia University in New York.

US shale producers, which Opec had hoped it could push into bankruptcy, will use higher prices to drill new wells, and American consumers, who have enjoyed the lowest petrol prices in more than a decade, will pay more at the pump.

Just months ago, Mr Al-Falih's predecessor, Mr Ali Al-Naimi, proclaimed that it did not matter whether oil prices went "down to US$20, US$40, US$50, US$60 a barrel - it is irrelevant".

Mr Al-Falih now says prices, hovering under US$50 a barrel, need to rise to encourage long- term investment.

In 2014, when Saudi Arabia led Opec's pump-at-will policy, Riyadh calculated that if it reduced output, prices would not rise enough to compensate. This time is different.

"Saudi Arabia is betting that a small cut will pay for itself through higher oil prices and hence higher revenues," said Mr Jamie Webster, a fellow at the Centre on Global Energy Policy at Columbia University in New York.

It is not as if the pump-at-will policy has not had its moments. Saudi Arabia has achieved some of its objectives. Low prices tossed water on the US oil boom, and energy companies have cut as much as US$1 trillion (S$1.36 trillion) in new projects, creating a possible supply hole in the next decade.

The kingdom has also scared investors, who are now more likely to think twice before plunging money into risky oil ventures. And from the US to China, sales of petrol-guzzling cars have soared, bolstering demand.

For all the justifications, the last two years have not panned out as Riyadh thought they would. At home, the kingdom has burnt through more than US$150 billion of foreign exchange reserves, government contractors have gone unpaid, and this week the king announced unprecedented pay cuts for civil servants.

Saudi Arabia will suffer a fiscal deficit equal to 13.5 per cent of gross domestic product this year, the International Monetary Fund estimates. When it comes to economic growth, Saudi Arabia is slowing sharply to about 1 per cent this year, while Iran, its nearby rival, is accelerating towards 4 per cent.

The pump-at-will policy brought chaos to the oil industry as prices tumbled from US$100 a barrel to a 12-year low of less than US$30. Companies tightened their belts, cancelled projects and sold assets. But they kept pumping.

That may continue even as the Saudis advocate a reversal. Producers who fell in love with drilling projects approved during the boom years of $100-plus a barrel have kept production humming from the Gulf of Mexico to Brazil.

Iran will be exempt from capping production, a major concession by Saudi Arabia. Many of the details remain to be worked out and Opec will not decide on targets for each country until its next meeting at the end of November.

BLOOMBERG

A version of this article appeared in the print edition of The Straits Times on September 30, 2016, with the headline 'Saudis choose higher prices over free oil markets'. Print Edition | Subscribe