Project Syndicate (USA): radically new oil strategy in Saudi Arabia

Princeton the Recent decision by Saudi Arabia to increase oil production represents a drastic change in her views on energy markets and on its dependence on oil revenues. Gone are the days when the reserves of Saudi oil wisely managed for future generations. No longer endorsing a certain price range for oil or keeping spare production capacity, the Kingdom is in retreat from its longtime role as a swing producer in the market.

This change reflects the opinion of the crown Prince Mohammed bin Salman (MBS) that Saudi Arabia has a relatively narrow opportunities to monetize its large oil reserves. He began a policy of capturing market share instead of trying to fix the price, again breaking a long-standing policy that, in his opinion, was useless.

If MBS will continue this strategy, it can drastically change the dynamics of world energy markets. Maintaining low prices, the Saudi policy is not just wiping out more expensive forms of oil production; it is also more difficult competition of renewable energy with fossil fuels — at least in the short term.

the New strategy became apparent on 7 March, Saturday, when Saudi Arabia decided to reduce its official sales price and to increase oil production to more than ten million barrels per day, while in April production is likely to be around 11 million, compared with 9.7 million in recent months. When the following Monday the markets opened again, oil prices have undergone the biggest since 1991, a one-day drop.

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Officially, the Saudi move was a response to the refusal of Russia on March 6 at the meeting of OPEC to agree to voluntary reductions in oil production. Since 2016 the Russians and the Saudis coordinate their production to support prices at around $ 50-60 per barrel. However, the net effect of this cooperation has been aimed at the us shale industry to increase its own production and sales, which thus captured most of the world’s growing demand. Faced with the reduction of exports in 2016, the Saudis are probably hoping the lower output will support prices in the context of a weakening global demand due to the outbreak of coronavirus.

Why the change of tactics? Commentators have offered various explanations, including hints that Saudi Arabia might collude with Russia to undermine the slate industry of the United States. But such cooperation is unlikely. Between the MBS and the President of Russia Vladimir Putin remain suspect, Putin has not forgotten that the machinations of Saudi Arabia in the oil market in the 1980-ies, may have played a role in the collapse of the Soviet Union. Moreover, Saudi Arabia has tried and failed to get on top of the oil shale industry in 2014 — 2016, when it grossly underestimated the technical competence and the ability of American producers of oil shale work at competitive prices.

Instead of having to seek short-term tactical victory, MBS can focus on several long-term development. He knows that his time is very limited — perhaps only a few decades to extract maximum benefit from oil, as climate change has sparked a global push towards decarbonization and renewable energy. Saudi Arabia has reserves of recoverable reserves of more than 50 years; if not to speed up their production, most of this will be the impaired asset.

Even if the Kingdom would face serious technical and financial obstacles in achieving their new, highly ambitious business objectives, a deeper problem is that the old rules no longer apply. In accordance with the new decision, the Saudis can begin to manage state oil giant Saudi Aramco, is more like an international company seeking to maximize profit — producing as much as possible — and not on the Central Bank of the world oil market.

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There is a strong case for why the Kingdom should go this route. First, Saudi oil is cheaper to produce and transport than many other stocks. It also “cleaner” than that produced in Canada from tar sand and produces less methane in comparison with Russian oil. And Saudi Aramco is one of the most advanced and technically competent oil companies in the world. In other words, Saudi oil many comparative advantages over competitors, and therefore, it is ideal to enjoy a privileged position in the global transition to clean energy.

moreover, the Kingdom has for several months signalled its intention to change the strategy. In December 2019 it has commenced an initial public offering of 1.5% of the shares of Saudi Aramco, which is one of the ways to monetize the initial value of their oil reserves, and signaled the shift toward profit maximization. After years of debate, the Saudis have also reached agreement with Kuwait about oil production in the Neutral Zone, which will allow to increase production to 500 thousand barrels per day. Finally, Saudi Arabia has recently announced plans to develop massive unconventional gas reserves Japura, which will lead to the production of even more oil available for export.

Changes in the policy realm should give pause to American politicians who boast that the United States through the shale has reached energy independence. In an all-out war for market share in the United States, Canada, Russia and other oil producers will be difficult to compete with the Persian Gulf, given its lower costs and other competitive advantages.

the Question, of course, is how long Saudi Arabia will be able to support this strategy before the new environment with the low prices will drain her own Treasury. Preliminary calculations suggest that it can last two years.

MBS, perhaps, is betting on that he will be able to survive the competition. But given the structural features of the oil market and the inevitable global transition to renewable energy, he probably saw no other alternative. OPEC quotas and production agreements with the Russians have not given the necessary results. And it is not clear, will the new policy more tangible benefits.

Bernard Heykel, Professor of middle Eastern studies and Director of the Institute for transregional studies of the contemporary Middle East, North Africa and Central Asia at Princeton University, is co-editor (with Thomas Hegghammer and Stephane Lacroix) the magazine “Saudi Arabia in transition”.

the new York times contain estimates of the solely foreign media and do not reflect the views of the editorial Board of the new York times.