For much of the past two years, a continuous increased output of crude oil from the wells of Saudi Arabia has flooded the world’s petrochemical market and kept the price of a barrel of crude oil artificially low, resulting in a decline in profitability for oil producers worldwide. The glut has been made worse by drastically decreased demand for oil in developing economies, many of which are slowing. With the price of a barrel of oil now below $37, there is a question that demands an answer: how far will the government of Saudi Arabia go to keep up this supply pressure on the world oil market?
What Motivates Saudi Arabia to Keep up the Glut?
Salman bin Abdulaziz Al Saud, the current King of Saudi Arabia. Salman continued the oil glutting policy after inheriting the throne from his half-brother Abdullah in January of this year.
Before answering how far the Saudis are willing to go to keep world oil supplies unusually high, it is important to understand the twofold reason for the creation and continuance of the oil glut. The first and most important reason for the glutting of the oil market is to keep pressure on producers that do not have Saudi Arabia’s output capabilities, such as American hydraulic fracturing firms. Companies and countries with lower oil outputs are forced to either sell their oil at a substantially lowered price or to cease production until prices begin to move back up, thus losing much of their market share.
The second reason for the continuation of this glut is that Saudi Arabia is determined to avoid the missteps it made during a similar set of circumstances in the early 1980s. A glut at that time, caused more by decreased demand than increased supply, forced OPEC to cut production several times while other suppliers did not. In the end, OPEC’s edge as a leading oil producer was lost until Saudi Arabia ended its own production cuts in 1985. While a cut in Saudi oil production now could easily bring the price of oil back to more stable levels, the country’s vast oil wealth is applied to forcing its competitors into the position of decreased production it took during the glut of 30 years ago.
Saudi Arabia’s Economic Structure
The question of how far the House of Saud is willing to carry the oil glut is largely determined by the economics that drive the country. The monarchy’s incredible wealth derived from ownership and taxation of oil resources has, for many decades, been used to keep the government running without the need to borrow money for day to day affairs. For the first time in years, however, the Saudi Arabian government operated at a deficit in 2015 as a direct result of decreased oil revenues. Spending cuts were instituted in an attempt to make up some of the shortfall, but they were not enough to balance the country’s budget. This is the first indication that the glut is beginning to take its toll on the Saudi economic structure.
What many in the West do not know is that there is a large untapped source of revenue in Saudi Arabia. Due to the nation’s oil wealth, individuals residing or working in the country pay no taxes on their income whatsoever. This tax policy has been one of the reasons that the Saudi monarchy has remained widely popular despite its often authoritarian nature. Were the country to find itself in dire straits, this source of revenue could potentially be drawn upon. This, however, is almost certainly a line that the monarchy will not intentionally cross, even to keep up the oil glut.
Where Does the Glut End?
Since its beginning in the second half of 2014, the Saudi oil glut has driven oil prices far lower than analysts originally predicted. Already, Saudi Arabia has found itself financially damaged as a result, with spending cuts, deficit spending and even the privatization of state-owned assets resulting from lower revenues. At the end of November, representatives of the Saudi Energy Ministry even pledged to work with other world oil producers to stabilize prices. However, the oil prices that we see today are still much higher than the inflation-adjusted prices seen during the glut of the 1980s, which hit a low of just over $22 a barrel in today’s money.
At $50 per barrel, the Saudi government was already operating at a deficit. At below $40, the damage to the Saudi economy is beginning to become more apparent. The next major price support point, that being $30 per barrel, is almost certainly where the glut will have to end. Even though Saudi Arabia has large reserves of wealth and the ability to generate more revenue by imposing an income tax and cutting social spending, the effects on the economy and on the popularity of the monarchy would likely be considered too costly to be worth continuing to decrease profits from oil.
How Easily Can Saudi Arabia End the Glut?
Contrary to some popular belief, Saudi Arabia’s control over the state of the oil markets at the moment is not absolute. Continued oil output by struggling countries such as Venezuela and Brazil, American hydraulic fracturers and Russia’s massive energy industry have also contributed greatly to the declining price of oil. At the same time, decreased demand has also caused world oil reserves to grow. A cut in production back to a more normal level would have a long term stabilizing effect on the price of oil, but would be unlikely to return it to the prices in excess of $100 per barrel that were commonplace only a few years ago due to the decrease in world oil demand since that time.
By Secretary of Defense [Public domain], via Wikimedia Commons
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