Two years ago, the Saudi government put in place a strategy intended to protect its position in the world oil market. The plan was to increase their production to the point where prices fell. The aim was to squeeze other producers, in particular the US shale industry, and force them to cut output. The belief then was that the US industry needed a price of around $90 a barrel to keep going. Once prices fell below that level, the Saudis thought they would have protected their market share, and in the process, sent a sharp warning to others, particularly the Iranians who want to restore their production following the nuclear deal with the US.
The strategy has not only failed but has caused serious damage to the Saudis themselves. Prices fell much further than anyone anticipated because other participants in the market did not respond as expected. The Saudi increase in production has not destroyed the US industry – American output has fallen only marginally despite a 70 per cent drop in prices. The kingdom simply underestimated the resilience of the US producers and their ability to cut costs.
Far from forcing others to cut output, the price fall has created an incentive for everyone to maximise production to squeeze out as much revenue as possible. The Saudis missed the fact that once the main capital investment in an oil field has been made, the economic logic is to keep producing come what may. The price drop has destabalised countries that depend on oil revenue from Algeria to Venezuela, many of which were traditionally Saudi allies. And the kingdom has been forced to run down its financial reserves to maintain spending. Meanwhile, the Iranians have increased production and plan to do much more.
That all represents a pretty comprehensive strategic failure.
After two years of denying reality the Saudis, under the guidance of a new more pragmatic oil minister, Khalid al-Falih, have accepted that the only way of managing the market is for them to cut production. Opec has agreed a broad target, which might be confirmed at its next meeting in November if two big problems can be overcome.
First, the cut as discussed does not look sufficient to mop up the existing stock overhang or the continuing increase (of perhaps another half million barrels a day) that the Iranians are demanding. A bigger reduction will have to be agreed if the price is going to rise. The market’s initial reaction to the prospect of a cut of less than 1m barrels a day was lukewarm. The price has struggled to reach $50 a barrel. To reach $60 or even $70, which is said to be the real target, a cut of perhaps 2.5m to 3m barrels a day is necessary and will have to be maintained for some time. That is particularly true given that a price rise will encourage producers, especially in the US, to bring back on stream wells that have been temporarily shut in.
Second, Opec has to allocate the cut between its members. A few countries can make token contributions but it is hard to see any way in which the bulk of the cut will not fall on Saudi Arabia. It is a fine calculation of volume and price but the net outcome could be that if prices rise only modestly – say towards $60 – the Saudis will end up with lower revenue. Another strategic triumph.
What went wrong? The answer is a mixture of hubris, inexperience and – most important – a failure to understand the evolution of the oil market and in particular the role of the industry in the US. There, in contrast to the situation in most Opec member states, the instinctive response to a price challenge is to cut costs, not least through technology. The Saudis clearly do not understand how a genuine market economy works, which is why all the rhetoric about new economic plans for the country built on a fairy tale presentation from consultants is going nowhere. Nor is the proposed sale of a minority stake in Aramco. Saudi Arabia is simply not ready for the level of transparency – not least on reserves – that a listing on the London or New York stock exchanges would require.
All this comes at a time when support for the kingdom – in the west and the Middle East – is weaker than it has ever been. The headline on the front page of the latest issue of the New York Review of Books reads “How Nasty is Saudi Arabia?”, linked to a forensic critique by the Economist’s Middle East editor Nicolas Pelham. Two weeks ago, the US Congress voted overwhelmingly, and in defiance of President Barack Obama’s wishes, to allow American families to sue the Saudis for their alleged involvement in the 9/11 attacks. In the region, Iran is winning the battle for hearts and minds – helped by the Saudi’s cruel and impotent war in Yemen. The kingdom is isolated.
Could things change? There are certainly technocrats – such as Mr Falih – who are able to manage the economy more sensibly. There are politically astute Saudis who recognise that the country can only lose if the conflict with Iran escalates and the isolation is compounded. Unfortunately, Mr Falih is one of few people in either category who have stayed to work in the Saudi government. Most have moved to London or New York well away from the Wahhabi fundamentalism that which is still the ruling creed of the country. Without their presence real change looks impossible.
In any normal business, a strategic failure on this scale would result in heads rolling. In Saudi Arabia heads do roll – a beheading last week was this year’s 124th execution, according to Agence France Presse. But even taking the phrase ****phorically it is hard to see how the kingdom can make the changes necessary when those responsible for the failures of the last two years are members of the royal family.
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🔴🔴🔴🔴 فناننشيال تايمز: الفشل الاستراتيجي السعودي 🔴🔴🔴🔴🔴 
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