Petroleum

Low Oil Prices Are a Win for Saudi Arabia

Low Oil Price Challenges

For nearly all of the world’s major oil-producing countries, low oil prices create tremendous social, economic, and political challenges. For these countries, there can even be dire consequences from collapsing oil prices. While prolonged periods of low fossil fuel prices can create a number of challenges for the global economy as a whole, nations that depend on fossil fuel production experience a heightened level of socioeconomic pressure when the price of oil and gas remains low. Quantifying these socioeconomic consequences has become an important subject that economists and policy makers have strived to assess for decades. Recurring oil price crashes and subsequent price spikes have a diverse range of worldwide impacts that are critical to evaluate. While 2020’s negative oil price debacle has plagued many oil-producing countries, some economic analysts say that Saudi Arabia may be best positioned to withstand this historic price collapse.

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Saudi Arabia

Saudi Arabia is one of the world’s most important oil producers and also serves as the leading nation involved in the Organization of the Petroleum Exporting Countries (OPEC). Saudi Arabia holds about 18 percent of the world’s known reserves of crude oil, which has helped propel Saudi Arabia to become the largest exporter of crude in the world (OPEC, 2019). Oil was first found in Saudi Arabia in March of 1938 in the Dammam oil field at a depth of about 1,440 meters below the ground. However, with World War II breaking out shortly after this discovery, oil production wouldn’t ramp up until the post-war period. Today, Saudi Arabia’s oil and gas industry makes up nearly 50 percent of the country’s gross domestic product (GDP), and roughly 70 percent of all export revenue (OPEC, 2019).

According to research conducted by the macroeconomic intelligence firm Fitch Solutions, Saudi Arabia’s proven crude reserves are about 256.8 billion barrels of oil, while the country also holds about 35.1 billion barrels of natural gas (Fitch Solutions, 2019). The majority of these fossil fuel reserves are located within Saudi Arabia’s northeastern provinces, which share a border with Iraq and Kuwait. The location of these reserves has proven to be a point of conflict for many years, with varying claims by Saudi Arabia’s neighboring countries that the reserves may also be located within their respective countries. About half of Saudi Arabia’s proven oil reserves are clustered in only nine oil fields, which are known as the Abqaiq, Ghawar, Khurais, Khursaniyah, Manifa, Safaniya, Shaybah, Qatif, and Zuluf fields. Exploration for new oil and gas reserves is limited to Saudi Aramco, which is the country’s gigantic state-owned oil conglomerate.

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An Unprecedented Collapse

As the global oil market has been dealing with a tremendous drop in demand coupled with storage capacity issues, the price of oil has proceeded to collapse precipitously. With the coronavirus pandemic destroying the global demand for fossil fuels and crude oil producers still pumping oil, the only place for oil prices to go has been down. The unprecedented collapse has ravaged national budgets throughout the oil-producing world. As the price of oil continues to drop, the countries that rely on oil revenue the most for their national budgets have experienced the most social and economic pressure. The extreme shock to global oil demand has uprooted entire budgets and created tremendous uncertainty for many countries, particularly those in the Middle East.

While many oil-producing nations are struggling, Saudi Arabia may be best poised to weather an extended period of historically low oil prices. During the height of the negative oil price scare, Christian Malek, who is J.P. Morgan’s chief of oil and gas equity research for Europe, the Middle East, and Africa, said that Saudi Arabia will be the winner in a scenario where oil prices don’t achieve a swift recovery. In a CNBC interview, Malek described how Saudi Arabia ramped up selling oil during the very beginning of the year as oil prices hovered around $50 per barrel. This added to the country’s financial reserves. As oil prices collapsed, Saudi Arabia was then able to reduce oil production. While almost nobody could have predicted 2020’s historic oil price collapse, Saudi Arabia has employed a strategy to withstand the chaos.

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Weathering the Storm

David Ernsberger, who is the head of global commodities pricing at S&P Global Platt, also agrees that Saudi Arabia is one of the only winners in a world characterized by extremely low oil prices. However, Ernsberger also believes that Russia may be able to weather the oil price storm. In fact, given that Saudi Arabia and Russia engaged in an oil price war, some economists and energy analysts have hypothesized whether these two countries have been purposely engaging in activities to reduce the global price of oil. While some economists have lambasted this theory as simply a conspiracy, others have suggested that critically low oil prices in the short term may benefit both Russia and Saudi Arabia in the long term. While extremely low oil prices could permanently damage the American shale oil industry and other major oil-producing countries, Russia and Saudi Arabia have the financial assets to be able to withstand the short-term chaos, which could help them achieve greater influence over the world’s production of oil in the long run.

Saudi Arabia has a tremendously sophisticated and efficient system for fossil fuel production. Production data from Reuters News Agency has shown how Saudi Arabia has been able to achieve oil production at an astonishingly low cost of $2.8 per barrel, which is by far the lowest cost of oil production in the world. Conversely, American shale oil producers need oil prices to be 14 times higher than Saudi Arabia just to cover the cost of producing the oil (Oxford, 2020). With historically low oil prices, American energy companies with high production costs in states like Texas, New Mexico, and Oklahoma are struggling to stay afloat. Until oil prices rise again, many American shale oil producers will be forced to halt production, while Saudi Arabia is able to continue to cheaply produce oil.

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Financial Challenges Remain

Even though Saudi Arabia is able to produce oil cheaper than any other country, the International Monetary Fund says that oil prices need to reach $78.30 per barrel for Saudi Arabia to be able to balance the government’s budget. On the other hand, Russia is able to fully fund its national budget when oil prices reach $40 per barrel (Worland, 2020). While both Russia and Saudi Arabia are able to produce oil efficiently, Saudi Arabia may have to cut spending on social programs to balance its budget. However, Saudi Arabian officials have yet to signal whether the country will have to liquidate assets or tap into its financial reserves to achieve a balanced financial plan. Instead, the country looks poised to double its overall debt as a result of the catastrophic drop in oil prices. Saudi Arabian finance minister Mohammed al-Jadaan has conveyed that the country is prepared to increase its overall debt ceiling from 30 percent of Saudi Arabia’s GPD to 50 percent of its GDP (Omran and England, 2020).

In March 2020, Saudi Arabia significantly increased oil production to record levels and provided substantial discounts for its exported oil in a dramatic attempt to retaliate against Russia’s failure to cut oil production to stabilize prices. This led to the initiation of the all-out oil price war between Russia and Saudi Arabia. Cinzia Bianco, who is an energy and policy researcher for the European Council for International Relations, described the results of the price war in an interview with Barron’s. “It cost the global energy market almost two months of spectacularly low oil prices but, with the largest deal to cut production in history, Saudi Arabia has won the oil price war” (Chopra, 2020). By implementing a series of strategic oil production adjustments, Saudi Arabia was able to use its massive financial reserves to make impressive moves to regain dominance of the global oil market.

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American Criticism

In response to Saudi Arabia’s strategic efforts to regain control of the oil market, some U.S. lawmakers have called for action against the country. While Saudi Arabia was focused on becoming the world’s most influential oil producer once again, American oil producers suffered through some of the most challenging times in history. U.S. Senator Kevin Cramer has been one of the most vocal American lawmakers to call out Saudi Arabia for its moves that have damaged the American oil industry. Cramer has called on President Trump to take action in response to Saudi Arabia’s attempt to flood the global markets with oil. One of his proposals is to ban all Saudi Arabian oil tankers from delivering oil in the United States. In response to this plan, President Trump has indicated that he would consider banning oil imports from Saudi Arabia.

U.S. Senator James Inhofe from Oklahoma has also echoed Senator Cramer’s sentiment in a letter that was sent to U.S. Commerce Secretary Wilbur Ross. In his letter, Inhofe demanded that Secretary Ross work with President Trump to put tariffs on Saudi Arabian oil for trying to bankrupt American oil companies. Inhofe also called for action against Russia for partaking in the oil price war to weaken the American economy. While U.S. consumers overwhelmingly favor low gasoline prices, falling oil prices have been shown to have an adverse impact on America’s supply of oil, which could undermine the country’s national security.

In response to pressure from U.S. oil producers, President Trump has been lobbying Russia and Saudi Arabia to increase oil prices. The last time that an American president asked Saudi Arabia to raise oil prices was in 1986, when President George H.W. Bush personally visited Saudi Arabian King Fahd to ask him to work to stabilize oil prices after they had crashed by over 60 percent (Bordoff, 2020). As the U.S. has become the world’s biggest producer of oil, America has become even more dependent on rising oil pricing. While low oil prices were once a net positive for the U.S., low oil prices have now become much more detrimental for much of the American economy that is involved with the fossil fuel industry. With this in mind, some economists and energy experts have suggested that now may be a good time for the U.S. to move away from its oil-dependent economy.

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Oil Dependency

Columbia University’s Center on Global Energy Policy and Resources for the Future has recommended that U.S. policymakers use this period of extremely low oil prices as the opportunity to move away from oil dependency altogether, rather than continuing to prop up the American fossil fuel industry. Managing dependence on fossil fuel production could help oil-producing nations better withstand periods with volatile energy prices. However, even with some policymakers calling for changes to the American fossil fuel industry, the Trump administration has been implementing policies that will keep America dependent on oil, like the gutting of vehicle fuel efficiency standards.

Sources

Bordoff, J. (2020). “5 Reasons Why a Global Agreement to Prop Up Oil Prices Won’t Work.” Foreign Policy.

Chopra, A. (2020). “Saudi Arabia Wins Oil Price War – At A Huge Cost.” Barron’s.

Fitch Solutions. (2019). “Business Monitor International: Saudi Arabia Oil and Gas Report.” Fitch Solutions Group.

Lee, J. (2020). “How Saudi Arabia Can Save the Global Oil Industry.” Bloomberg.

Meredith, S. (2020). “Saudi Arabia is the winner from oil’s historic price plunge, analysts say.” CNBC.

Obaid, N. (2020). “Saudi Arabia just won control of the oil market.” CNN.

Omarn, A., and England, A. (2020). “Saudi Arabia to double debt in virus and low oil price fight.” Financial Times.

OPEC. (2019). “Saudi Arabia facts and figures.” Organization of the Petroleum Exporting Countries.

Oxford, N. (2020). “The oil price war is a nightmare for US shale producers.” Aljazeera Media.

Worland, J. (2020). “Answers to Six Key Questions About the Oil Price Collapse.” Time.

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