In the 1980s, Saudi Arabia had a problem. Energy demand was sluggish and the kingdom had just brought a lot of supply on line by opening new fields. The combination led to falling energy prices, which meant less money for the country.
In response, Saudi Arabia cut output, hoping the drop in supply would send prices higher.
The only problem was that other oil producing nations didn’t toe the line. Instead, they kept pumping which meant that these other producers were effectively taking market share from the Saudis even as prices remained low, which is like losing twice.
This time around, the Saudis aren’t taking the bait.
This Isn’t Altruism
The country did cut monthly oil production by about 5% in August, and just a touch more in September, but they’ve not made dramatic shifts in output.
As energy prices keep falling in the face of rising supply and sluggish world demand, the Saudis appear to be comfortable with the current pricing of energy through the rest of the year. They even lowered the price of oil to the U.S. recently.
There is no question the country will lose revenue due to lower prices, but they aren’t willing to risk losing market share, which is much harder to regain.
All of this is great news to consumers and businesses, who have engaged in the biggest wealth transfer in the history of the world as they bought oil from the Middle East. Falling prices, particularly near the holidays in Western nations and as winter approaches in the Northern Hemisphere, are a welcome relief to budgets large and small.
But chances are that the Saudis are not allowing the price of oil to drop out of altruism. Instead, they are probably hoping to be the last man standing on two different fronts, by squeezing countries that need more revenue to balance their budgets, and rendering high-priced energy production unprofitable.
Many of the large Middle Eastern and African members of the Organization of Petroleum Exporting Countries (OPEC) need oil above $90 per barrel to balance their budgets. This includes Saudi Arabia, but that country has wealth it can draw on and a very strong relationship with the U.S.
Other countries aren’t well situated to keep taking losses on their main export, including Iran. While Saudi Arabia needs the price of oil to remain at $90 per barrel or above, the Iranians need the price of oil to reach $140 before their budget is balanced.
Watching prices go the other way has to be painful for Iran, which is probably very satisfying to Saudi Arabia since the two countries are long-time adversaries. Saudi Arabia is Arabian and mostly Sunni, whereas Iran is Persian and mostly Shiite.
This leads to proxy battles in places like Lebanon and Iraq, as well as fights in business.
At the same time that Saudi Arabia is causing pain for its old foe Iran, the country is also putting pressure on competitors that have high production prices, like the upstart fracking industry in the U.S. and tar sands producers in Canada.
While traditional barrels of oil from the shallow waters of the Gulf of Mexico or the Permian Basin in Texas cost much less than $90 per barrel to produce, break even for many of the newer producers is reportedly between $75 and $80.
Low Prices Weigh More Than Jobs
If prices drop much below $80, it’s possible that many of the new oil producers will have to cut back production dramatically because the operations will be unprofitable.
This suits the Saudis just fine, since it means less competition in the future. Even if (or when) prices go back up, it takes time to ramp up oil production, transport, refining, etc., so the Saudis will have gained an advantage.
While Americans will be thrilled with cheaper gas and heating oil, any drop in energy production will hurt the economy through the jobs market. If the employment gains in Texas since the financial crisis are taken out of the equation, then employment levels in the U.S. are still below what we had in 2008.
Is cheaper gas worth a loss of jobs? That’s a really good question that unfortunately doesn’t have an easy answer.