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Dissecting Saudi oil minister Naimi’s speech

Saudi oil minister Ali al-Naimi spoke in Berlin on 4 March, giving his view of the market and explaining the kingdom’s oil policy

The speech raised more questions than it answered and highlighted the difficult position Saudi finds itself in. On one hand, Naimi thinks the kingdom’s strategy of allowing the market to correct is working, suggesting there is no need to change tack. In the same breath, though, he implied that if a “consensus” involving other non-Opec producers could be reached, the kingdom would be willing to cut; it’s just not going to do it alone.  

The key extracts are below, with Petroleum Economist’s commentary on each. Italics are all ours. The full text is available here.

No change in tack…

Naimi: “Over the past eight months … with the market in surplus, it is Saudi Arabia that is called upon to make swift and dramatic cuts in production. This policy was tried in the 1980s and it was not a success. We will not make the same mistake again.” 

PE: This is core to Saudi Arabia’s new laissez-faire policy. The kingdom’s finances are in better shape now than they were in the 1980s. Unlike then, it now has the resources to face a lengthy spell of lower oil revenue. Naimi even talked in an interview with Mees earlier this year of the kingdom running a deficit, or even borrowing money. So, implied Naimi in Berlin, there will be no shift in policy until higher cost suppliers are forced out of the market.  

That being the case, why is Saudi Arabia not pumping even more oil to speed up the process? The answer may be that while $60 a barrel (b) is painful, the shock of $30/b would be dangerous. However, $60/b – a price still above the long-term historical average for Brent – may not be low enough to force rival producers out of the market. The risk in not pushing harder is that it may leave space for higher-cost North American suppliers to become more efficient, while still spreading hardship in Opec’s most profligate member states, whose governments are less able to streamline budgets than US tight oil producers.  

…But we still might cut, if

Naimi: “Today, it is not the role of Saudi Arabia, or certain other Opec nations, to subsidize higher cost producers by ceding market share. And the facts on the ground are very different anyway. Non-Opec supplies are much larger than they were in the 1980s and a much more multi-national approach is required. Saudi Arabia remains committed to helping balance the market but circumstances require other non-Opec nations to cooperate. Currently, they choose not to do so. They have their reasons. But I would like it to be known that Saudi Arabia continues to seek consensus.” 

PE: This is the most curious statement in the speech and reveals a contradiction in Saudi policy. Essentially, Naimi’s speech says: not cutting was the right decision… but we’re willing to cut if others come on board. It is a confusing message.  

It may be aimed at Russia and Mexico. Ahead of the Opec meeting in November, Naimi met with the oil ministers from both countries – part of a deal with Venezuela, whose own minister had been charged (by Naimi) with getting Russia and Mexico to agree to cuts

The problem for the market is this: either the Saudi policy of letting the market drift down is strategic, designed to regain market share; or it is tactical, designed to force other producers into line by showing that Saudi Arabia will only cut if they do too. If Russia and Mexico agreed, Naimi seems to be saying, the kingdom would abandon its hands-off market strategy of the past few months and get back to business. The position is difficult to square with everything else that has been said about forcing higher-cost producers out of the market. 

No price war? 

Naimi: “With the recent price drop, Opec and Saudi Arabia have yet again been maliciously – and unfairly – criticised for what is, in reality, a market reaction. Some speak of Opec’s ‘war on shale’, others claim ‘Opec is dead’. Theories abound. They are all wrong.”

PE: Opec is clearly not dead. Its decision to do nothing in the face of collapsing oil prices in November was the seminal moment for oil markets in the past few years. But it’s hard to understand why the “war on shale” talk upsets Naimi: his own statements have tended to support that description. First, in the Opec meeting itself, reliable sources say his argument to the other ministers explicitly mentioned the threat to Opec coming from rising North American tight oil supply (which has pushed a lot of Opec crude out of that market). Second, Naimi was explicit in his Mees interview: it was “crooked logic” for Opec to support prices, he told the newsletter, “while the inefficient producer continues to produce”. Cutting would push up prices “and the Russians, the Brazilians, US shale oil producers will take my share”.

Perhaps Naimi’s problem with the “war on shale” description is that it is too narrow. The war is being fought against all those other “inefficient” producers too. Either way, the strategy is designed to recover market share through the weapon of lower prices. That’s known as a price war.  

On demand

Naimi: “When prices are rising, or at an historic high, as they have been over the past few years, the global oil industry tends to increase investment. So we have seen higher production from oilfields that are more costly to develop or operate, such as in the arctic, deep offshore, heavy oils in Canada and Venezuela, and shale oil deposits in the US. Ultimately, this additional production has come during a period when the global economy is recovering from a deep recession. Oil demand growth, particularly in Europe, has been impacted. These factors combined have led to an over-supply. If you add into this speculation about a future oil glut and potential falling demand, you get falling prices. This is how the oil market operates.”

PE: Few market-watchers would dispute Naimi’s view of supply-side dynamics: that high prices yielded more investment and production. But Naimi also seems to accept that the high price affected demand (”particularly in Europe”). This represents a modest shift in thinking for the Saudi oil minister, who previously saw $75/b or even $100/b as the “fair price” for oil. His view keeps changing, though. “I just came from Hong Kong,” he said two years ago, “and I told everybody, in 1996, I thought $20/b was reasonable; in 2006 I thought $27/b was reasonable and now it is around $100/b. I told them again it is reasonable”. “Reasonable” and “fair” are fluid notions, difficult to nail down. But triple-digit oil, he now seems to accept, was too much.   

Demand, again

Naimi: “From my perspective, demand is gradually rising, global economic growth seems more robust and the oil price is stabilising. Saudi Arabia’s quest for market share is simply an effort to satisfy rising customer demand. We seek calm markets, because this benefits everyone.” 

PE: Forget rig counts, the pace of future demand growth is now the outstanding issue for the market. Ordinarily, cheaper oil should help stimulate global GDP growth and therefore more consumption of oil. But new variables make this equation less certain. Some of the demand lost in the OECD is gone for good, thanks to the tightening of fuel-economy standards and the take-up of alternative fuels. 

It is possible that oil prices were high for long enough to bring secular changes in consumption, involving cultural shifts alongside technological advances (from internet shopping to urbanisation to electric vehicles, Zipcar and Uber). The halving of the price of oil in the past six months may stall some of this. Or not. No one is going to go back to dial-up internet because broadband costs more. Likewise, better-planned cities and more efficient engines have benefits for consumers beyond the lower energy inputs they need. They aren’t going away. 

As China moves from an investment-led to consumer-led economy, its oil consumption won’t grow as quickly as it did in the past decade. India, believe some oil exporters, might take up the slack, spurred by cheaper oil. But if global demand doesn’t respond to cheaper prices – if, say, consumption continues to grow at the tepid pace of the past year – “Saudi Arabia’s quest for market share” will amount to a blunder. 

The kingdom is not willing to produce much beyond 10 million barrels a day and has no plans to expand capacity significantly. So, however quickly the market grows, the kingdom will own a smaller slice of the pie over time. 

But, having allowed prices to drift lower to secure this market share, Opec has surrendered a great deal of revenue. Given the fiscal needs – even in the Gulf – this is only tolerable in the short term, and only if it self-corrects later. If it doesn’t, Opec’s decision in November will have had the effect of pushing prices into a new, lower band with little to show in return. Oman’s oil minister, Mohammad al-Ruhmy made this point at a recent Petroleum Economist conference in Kuwait. Opec’s daily revenue had almost halved to $1.5 billion, he noted. “I fail to understand how market share can be more important than revenue. This is politics I don’t understand.”

The alternative for Opec in November was to defend a price around $85/b. Yes, this would have surrendered market share in the process, but revenues would look a lot rosier than they do now. (It would also have sustained the non-Opec production growth Naimi said in this speech that he welcomes.) Instead, Opec may need to defend a much lower price again sometime in future. 

Falling costs

Naimi: “But while a down cycle causes oil industry pain, it brings benefits as well. A period of lower oil prices incentivises companies to take a more disciplined approach and focus on implementing production efficiencies.” 

PE: Greater capital discipline is certainly in order. But will the fall in industry costs do Saudi Arabia any favours? It already produces some of the cheapest-to-extract oil in the world, and its margins remain high. Falling inputs for the marginal players in North America that have been responsible for the global oversupply will make them more resilient to the weaker market, driving down the marginal price. In short, while some of the “less efficient” producers Naimi has talked about will be forced out of the market, the lower oil price will make others more efficient. And if demand rises, as Naimi believes it will, these producers – able to adapt drilling programmes quickly in response to market signals – will emerge from the downturn stronger, enjoying better margins, and making them harder to dislodge in future.  

Opec’s purpose

Naimi: “It has always been the aim of Opec nations to work together to do what they can to stabilise prices, ensure fair returns for producers and steady supplies for consumers.”

PE: There is some revisionism here. Cartels exist to maximise revenue by exploiting their domination of the market. Opec may be unable to do that now because rival supply has weakened the group’s power. But talk of “fair returns for producers and steady supplies for consumers” glosses over the reality Naimi alluded to elsewhere in the speech: that prices were left too high for too long, leaving Opec with few options when the inevitable market slump began. As for Opec working together, this is polite obfuscation. The Gulf countries with robust balance sheets, led by Saudi Arabia, were behind November’s decision. Nigeria, Algeria, Venezuela and others are suffering because of it and want the policy changed. Opec has rarely before been as divided as it is now. 

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