Why the Saudis want the oil price to keep falling

Neil Barnett

by Neil Barnett

Since March we have suggested, and then witnessed, a Saudi-US policy of pushing down oil prices to rein in Russia. Nevertheless, Saudi motives in doing this have mystified many observers. On the face of it, this mystery ended on 22nd December when the Saudi oil minister Ali al-Naimi gave a frank statement to Middle East Economic Survey intended to explain the Kingdom’s oil policy. He said:

“It is not in the interest of Opec producers to cut their production, whatever the price is. Whether it goes down to $20, $40, $50, $60, it is irrelevant.

“We have entered a scary time for the oil market and for the next several years we are going to be dealing with a lot of volatility. Just about everything will be touched by this…

“…We want to tell the world that high efficiency producing countries are the ones that deserve market share. If the price falls, it falls . . . Others will be harmed greatly before we feel any pain.”

The Saudis are prepared to endure prices as low as $20/barrel in order to knock out higher cost production from US oil shale and other sources. al-Naimi also said that the Kingdom would not hesitate to issue sovereign debt for the first time in order to make up for lost oil revenues, meaning the Kingdom would tolerate far lower prices than most analysts believed.

This statement will, among other effects, help to remove a floor from the oil price, since analysts can now discount the idea that it is in Saudi interests to prevent a further collapse; the sub-text of al-Naimi’s comments is that the lower the price the better in the next 12-24 months. It would be a very bold trader who bet on a sustained rebound in this period.

While there is little doubt Saudi policy is in large part motivated by al-Naimi’s stated aim of taking market share and pushing out the less efficient producers, it would be naïve to think this is a complete explanation (and equally naïve to imagine Saudi Arabia would openly declare economic war on Russia and Iran). This visceral fear that oil is in terminal decline as fuel and that Saudi will be swamped by new production from the US, Brazil and other sources compounds the rather beleaguered thinking of the Saudi leadership on other matters.

In short the al-Sauds (as well as the Emirati ruling family, who seem to have very similar views on the most important energy and security matters) fear that their days are numbered for the following reasons:

  • The revolutions of the ‘Arab Spring’ have struck fear into the hearts of the Saudi and Emirati elites. In particular they fear the ability of the Muslim Brotherhood to combine Arab Islamic legitimacy with its own form of constitutional democracy. This can be seen in the huge Saudi/UAE support for the al-Sisi regime in Egypt and the UAE’s persecution of al-Islah, an offshoot of the Brotherhood active in the northern emirates. It can also be seen in the UAE’s intensive lobbying on the subject in London.
  • Equally, ISIS is seen as an existential threat. The group disregards borders and does not recognize the traditional settlement between the al-Saud family and the religious establishment in Saudi Arabia. Unlike al-Qaeda’s various incarnations, it operates as a field army that could, in theory, challenge the Saudi armed forces.
  • The struggle against Iran and the Shia, which takes in the fight against the Assad regime in Syria brings Saudi into indirect conflict with Russia, which is the main armorer of the regime and supplies it with intelligence and diplomatic support. Similarly Russia is supporting Iran diplomatically at a delicate juncture in nuclear negotiations, and indeed is building civilian reactors in Iran (while Iran continues its domestic uranium enrichment programme). 
  • The fear that Saudi oil (and therefore Saudi itself) is of rapidly diminishing importance to the US. Since the US is the ultimate guarantor of Saudi national (and by extension, regime) security, this is deeply alarming to the al-Sauds. In physical terms the US commitment to the Gulf remains firm: the Fifth Fleet is still based in Bahrain and the forward headquarters of CENTCOM is still at al-Udeid in Qatar.  However, there are several indicators that US political commitment is waning. The first is the nascent and unspoken US rapprochement with Iran and Syria over ISIS. The second is the sense that Obama’s strategic pivot to Asia implicitly means less security resources for Europe, Israel and the Gulf Arabs (although the events of the last 12 months arguably render the ‘pivot to Asia’ obsolete). The rapid rise of US shale oil production further marginalizes the GCC states, most of whose oil exports now go to Asia (see EIA pie chart below, showing 68% of Saudi crude exports going to Asia in 2013, versus 19% to the Americas). There is a sense in Washington that it makes little sense for the US to provide security for China’s oil supplies.

Crashing oil prices therefore serves a number of inter-related Saudi objectives simultaneously. The Saudi and Emiratis think very carefully and deeply about strategic matters, and can pursue strategic objectives more directly and consistently than democracies can (with the obvious flip side that errors are likely to go uncorrected). In other words the great economic pain of this oil policy is being embraced only after deep consideration and in the belief that it serves the following ends:

  1. Defending Saudi’s position and significance as an oil producer and knocking out ‘less efficient’ rival production.
  2. Striking the state budgets of Iran and Russia. Of course al-Naimi’s comments do not touch on this, as Saudi Arabia would naturally prefer to attack the economies of Iran and Russia deniably.
  3. Reaffirming Saudi’s importance to the US as the regional security picture deteriorates, by a combination of points 1 and 2.

Of course the third point is slightly counter-intuitive, as the US cannot be pleased that its domestic oil industry is being disrupted in this way. But the US-Saudi marriage was always more one of convenience than love, and this policy will certainly remind the US that Saudi is still a serious player whose security is of direct importance to the US – and to common US interests in Russia and Iran.


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Anonymous - About 661 days ago

I think this is a clear assessment of one key part of the situation, but doesn't consider the role of China, who are the primary beneficiaries of both a weakened Russian economy and, as the largest net energy importer, a low oil price. The 'US-Saudi marriage' the article refers to was never consummated. There is a good account as to why from the Saudi's perspective in the book 'Inside the Kingdom' which looks at Kissinger's actions before, during and after the 73 war. Since then, the relationship has been at best one of convenience. Saudi strategists now look East not West as to who will buy their oil in the 21st century, and who will become their real long term partner. It isn't a bi-product that the current policy causes the US a problem with shale development; that is one of the Saudi-Chinese objectives.

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George Murray - About 660 days ago

Love the commentary.
All your points appear to be spot on except....
Future predictions of the results of these Saudi actions will, I suspect, invariably be wrong.
The "black swan event."
The theocracy of Iran, as their nation state approaches economic and demographic doom, may well decide the time has come for their swan song of utter destruction and death.
Or Putin, being the wealthiest tyrant on planet Earth, may decide that it's time to use his power and wealth to expand Imperial Russia.
Or the corrupt House of Saud may fall prey to its own Wahhabist fanatics and crumble that particular kingdom...

Whatever the results may be, the current oil glut; continued production; and sustained drop in price, is unprecedented (well, at least since Rockefeller) and will have unforeseen results.

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