The Financial Times
Nick Butler
The Saudis blinked. The latest deal — an agreement with Russia to cap oil output at January levels if they are joined by other large producers — will not rebalance the oil market immediately. The surge in prices last week was premature. But they blinked and that is all important. The myth of Saudi power is broken.
The real steps necessary to rebalance the market are yet to come. Saudi production must come down. Others may join in the process but a reduction of 3m barrels a day is necessary and most of that will have to come from Saudi Arabia. Stocks must be run off. That will take time. Iran must be welcomed back into the market. That process will be slow and even estimates that Iran can pump another 400,000 barrels a day this year look high. But Iran will come back eventually and need to be accommodated. The interests of other Opec member states, such as Venezuela and Algeria, must also be taken into account. The Saudis’ lack of respect for their fellow Opec producers over the past year has shaken many traditional alliances. The kingdom does not have that many allies.
China’s economic slowdown does not help, nor does austerity in Europe. But recessions end, and the combination of the coming elections in France and Germany, plus the disruptive impact of the migration crisis, should lead to more expansionist economic policies.
Even if Saudis blink again and cut production on a serious scale there are so many downward pressures that it is hard, short of a revolution in Riyadh, to see prices rising above $50 for three years or even more. Beyond that, potential supply growth still looks stronger than the likely growth in demand.
Within Saudi Arabia, the political implications of what has happened over the past week are not yet clear. The change of policy is a humiliation for Ali al-Naimi, oil minister. Power has shifted, although it is not yet clear who the winners will be.
More important for the long term is the shift of power in the oil market. The Saudis were not able to force the US shale industry out of business. The pain has been considerable, especially to the services sector but in the end the companies were able to cut costs in the US and elsewhere. The industry has had two bad years but it is still standing.
Market forces are certainly winners from the shift of power. Future prices will be set by the balance of supply and demand, not by decisions taken by any one producer or group of producers. There are multiple sources of supply with no sense of scarcity because technology is opening so many new opportunities. Of these, the most important is the potential growth of oil produced from shale rock.
On the other side of the market, demand is flattening out, with growth slowing even in the emerging markets. The latest figures show that Chinese demand in December fell year on year. Across the world demand continues to creep up but the pace is much slower than it was and total consumption may well never reach 100mbd.
The balance of supply and demand will set the price, forcing producers to respond by cutting output if the price falls below their comfort level. That prospect is limited, however, by the inability of most producers to tolerate cuts in production for long. Almost all the oil-exporting nations need to maximise their output and trade to remain solvent. They are trapped and must take any price they can get. Wise producers will begin the long-postponed process of economic diversification. There are signs that the Saudis are doing that. Russia, Nigeria, Venezuela and others still seem incapable of change.
The lesson of the past two years is that in an open global economy no one can defy the power of market forces for long. For the Saudis, the acceptance of the limits of their power must be very painful. They will not be the last to find that they cannot defy economic gravity.
