How Saudi Arabia Benefits From Low Oil Prices

How Saudi Arabia Benefits From Low Oil Prices

16 May 2016, 03:45
Diamond Ashiegbu
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How Saudi Arabia Benefits From Low Oil Prices

On June 19, 2014 Brent oil futures closed at $115.06, its highest level for the year. After that, oil prices started to free fall and as of March 12, 2015 oil was trading around $58 per barrel. Experts have two main reasons for this dramatic decline:

 

The increase of US shale production and an economic slowdown in Europe and Asian giants China and India, some of the biggest oil importers. The former doesn't seem like a strong argument because US shale production is only a tiny fraction of total daily oil production worldwide, around 90 million barrels, and therefore less likely to have a significant effect on prices (source:www.eia.gov).

 

So low demand is more likely the primary reason that drives the oil price down. (For more, see: Oil Price Analysis: The Impact Of Supply & Demand).

 

See attached file 1. 

Oil price needed to balance the budgets.

The dramatic decrease in oil prices have mostly hurt oil exporting countries' economies in the following ways:

1. Oil revenue is an important part of financing government expenditure. Therefore, low oil prices result in budget deficits, forcing governments to seek other sources to finance the deficit or reduce spending. (The above figure shows the oil price needed to balance the oil exporters’ budget).

2. Lower oil prices also mean lower foreign currency inflows, leading to a decrease in the countries’ foreign currency reserves. Almost all oil exporting countries’ economies depend on the import of goods or services and currency reserves finance this foreign trade. Decreasing currency reserves would lead to devaluation of local currencies against major international currencies such as the dollar and the euro.

 

OPEC, a consortium of oil-exporting nations, decided to maintain the current production level at a meeting in November 2014 despite expectations of a production cut. Saudi Arabia - the biggest oil producer with around 30 percent quota of the organization's total production (See attached File 2) - blocked calls for a production decrease from poorer countries in the organization.

 

Why did the country opt not to cut production? Saudi Arabia is one of the main players in the oil market, supplying 12-13 percent of the total daily oil output worldwide. As the second biggest oil producer after the US, it wants to preserve its share in the market and a cut in production would threaten this share, which takes a long time to regain.

 

Together, OPEC countries contribute about 40 percent of total daily oil supply worldwide, leaving 60 percent of the market share uncontrolled and making Russia and the US (Saudi Arabia's biggest competitors) dominant in the market. There is also no guarantee that a price increase resulting from a production cut would be enough to justify the decrease in supply and bring in the oil revenue that is crucial to balancing the budget.

 

Another possible reason behind the decision to maintain the production level is that Saudi Arabia wants to kick the smaller oil exporters - who would not be able to manage low oil prices for too long - out of the game and thereby increase market share by a couple of percentage points. In the short run, all oil exporting countries including Saudi Arabia are affected by the low oil prices. But Saudi Arabia benefits in the long run with estimated currency reserves of about $700 billion, allowing it to bear current low oil prices for a few more years.

 

Low oil prices also give Saudi Arabia political power over other oil exporting countries that are its political rivals. For example, Saudi Arabia clashed with Russia and Iran over the Syrian conflict when the latter kept supporting Bashar al-Assad's regime against Saudi Arabia and its western coalition.

 

The Bottom Line
Saudi Arabia's large currency reserves and dominant position in the oil market allows it to manipulate the current scenario to its favor. The country's ability to tolerate low oil prices for much longer than its competitors helps it squeeze weaker competitors out of the market and strengthen its political position against countries like Russia and Iran. 


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