Why Saudis Are Holding Strong on Oil
A consensus has emerged since the death of King Abdullah of Saudi Arabia that the kingdom will not change course on oil policy. This consensus is probably right, at least for the short term. It is, however, correct for reasons other than the ones that most observers have invoked.
Moreover, while it looks unlikely that the kingdom will alter oil production in the coming months, barring a major change of heart of non-OPEC producers, interesting changes to Saudia Arabia's cabinet roster and other energy policies and could be closer than most realize.
The basis of the conventional wisdom is rooted in personalities. New King Salman bin Abdulaziz has pledged continuity, stating he will adhere to the “correct policies” of his predecessors. He also said that oil minister Ali Al-Naimi will stay in his post.
While personalities certainly matter a great deal in Saudi Arabia, the real imperative to stay the course has little to do with the individuals who have come or those who will stay. Culture, as is often the case, plays a huge role determining why, at least in the short term, the kingdom will not cut oil production unilaterally.
It is nearly a truism to say that nothing is more respected than strength in the Middle East. And, in the wake of a transition of power at the highest levels, projecting strength is more important than ever. Despite the smoothness with which the dynasty has passed on to Salman, many inside and outside the kingdom have spent years fretting about the possibility of domestic unrest at this juncture. Moreover, with the region more volatile than at any point since the collapse of the Ottoman Empire, understanding the importance of projecting strength is key to accurately anticipating Saudi actions.
If the need to project strength is your touchstone for analysis, you'll conclude the Saudis are most likely to hold course in the near term. If you believe that the Saudi policy is first and foremost inspired by a desire to undermine the Iranian regime, you'll conclude that now would be the worst time to modify that approach. Some observers have suggested that the new king could cut oil production unilaterally, to relieve the economic vise squeezing Tehran and start a more constructive dialogue between the two countries. Indeed, since Abdullah's death the Iranian regime has been on a PR campaign pushing a "good neighborly approach" to regional problems. Don’t count on it. In the region, such a Saudi gesture would be seen not as an olive branch extended from a position of strength, but as an indication that the new king will lack the resolve of Abdullah.
What to expect, then, if you believe (as I do) that the Saudis are not primarily driven by geopolitical reasons? Then you will still come to the conclusion that change is unlikely in coming months. Saudi officials remain singed by the experience of the 1980s, when, in the face of a non-OPEC supply surge, Saudi Arabia cut production -- yet was still unable to bolster price. Looking at the changing dynamics of the oil market, particularly in light of the boom in U.S. shale production, Saudi officials are concerned about a repeat performance of that 1980s dynamic.
Even before Abdullah’s death, these same Saudi decision-makers almost surely worried that a unilateral cut in production, with no resulting boost to price, would suggest that Saudi Arabia had lost control of the oil market. Better not to try, than to try and not succeed. Nothing would project weakness more definitively. Now, as a new king assumes the throne, this logic holds more than ever.
So much for short-term change. But it would be over-confident to assume that the status quo will remain for the indefinite future. Technically, perhaps, Saudi finances can withstand low prices for many years. The budget for 2015 is expansionary, with a predicted $40 billion deficit. (And it appears to assume a slightly higher oil price than the currently sub-$50 per barrel levels, so the deficit could be even larger.) But running such deficits year after year is only sustainable if one assumes that oil prices will eventually rebound to higher levels, allowing Saudi Arabia to restore its coffers. So, what if these recent market trends are not outliers but the "new normal"? Saudi Arabia’s most astute decision makers certainly have that possibility on their minds.
Moreover, despite recent pronouncements that the succession will not result in cabinet changes, there are some good reasons to anticipate new ministers over the next half year, with resultant changes in policy, although not necessarily regarding oil.
First, new kings have traditionally liked to make their own appointments to power ministries. If Salman’s first cabinet appointment -- his 34-year-old son to succeed him as defense minister and also become chief of the royal court -- is any indication, the king will not be shy about reinforcing his influence in key posts. In addition, the selection of a grand-nephew of King Abdullah, Mohammed bin Nayef, as deputy crown prince and deputy prime minister did more than resolve the nerve-jangling question about how the crown will move from the generation of the sons of Saudi founder, King Ibn Saud, to that of his grandsons. It may also mean changes in the cabinet in the months ahead, as it would be unusual for the 55-year-old prince to preside over a cabinet of so many older princes of his own generation.
Finally, several top officials, including Naimi, the 79-year-old oil minister, and the ailing foreign minister, Saud al-Faisal, have been in their posts a long time -- and are rumored to have been kept on largely due to their personal relationships with King Abdullah. After the initial succession jitters have subsided, it may be an opportune moment for them to move to less stressful endeavors.
While a new oil minister may or may not mean immediate changes in oil policy, it is likely to directly affect other significant internal energy debates. Of these, perhaps the most interesting surrounds the possible opening natural gas development to foreign companies. In 1998, Saudi Arabia launched a “gas initiative” and welcomed some multinational firms to explore the country’s gas potential. Little came of the endeavor; there was apparently tension between technocrats behind the initiative and royal family members who questioned the wisdom of bringing outside companies in to develop Saudi Arabia’s natural wealth. (Keep in mind that state-owned Saudi Aramco is almost exclusively responsible for the production of Saudi oil.)
Yet the question of developing Saudi natural gas is again front and center, as the kingdom’s domestic energy consumption grows unabated and the country continues to burn oil -- which would be better exported -- to generate electricity. Getting some assistance to develop the hard-to-reach natural gas deposits not associated with oil production could be a good idea.
So, as Salman settles into office, don't expect big increases oil prices -- unless, of course, a contingent of both OPEC and non-OPEC producers including Russia and Mexico agreed to make significant production cuts alongside Saudi Arabia. The new king and his advisers will be rightly focused on projecting strength and confidence -- and that will mean staying on the current course. But it would be unwise to take the initial pronouncements of a new king to be long term policy and personnel commitments.
This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.
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