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Saudi Arabia and the crude market

(GCC FOCUS) / 25 June 2012

The latest Opec meeting in Vienna was not bullish for oil prices, which only rebounded due to prospects for monetary stimulus from the central banks.

A Saudi Aramco oil facility in the Saudi Arabian desert near Al Khurais, 160km east of the capital Riyadh. — AFP

Saudi Arabia refused to consider new quotas or any reduction in its 10mbd production, despite the demands of price hawks Algeria, Venezuela, Libya, Iran and Iraq. Opec must also face the fact that US domestic production is now the highest since the 1980s’, trails to shale oil. Russia is the world’s largest producer at 10.36 mbd while Iraqi production has soared above three mbd, the highest since Saddam Hussein invaded Kuwait in 1990. Baghdad is a new geopolitical force in Opec and its rising output will help offset the loss of Iranian oil as the July embargo emerges.

The second death of a Saudi Crown Prince in less than a year also means the oil market will become increasingly sensitive to succession in the Al Saud family. In 2008-09, as Brent lost $100 in six months as oil demand crumbled in the post Lehman credit crunch and global recession, Saudi Arabia cut production and engineered the biggest output cut in the history of Opec. Yet when Brent hit $125, Saudi Arabia expanded its output by 1.8 mbd above its Opec quota to prevent a global recession. The latest Opec ceiling of 30 mbd is purely public relations fluff since actual output is at least 32 mbd.

Saudi Arabia’s power in the oil market derives from the fact that it alone has the spare capacity to dramatically expand production and has engineered a free fall in oil prices, as the Kingdom did in 1986 during Sheikh Yamani’s netback pricing and again in the late 1990s.

The kingdom’s oil minister has publically called for a $100 price on Brent as optimal for producers. However, Brent has fallen 88 below the Saudi Oil Minister’s $100 target. In fact, oil prices plunged after the Fed FOMC did not greatly expand its balance sheet. China PMI contracted to 44, a grim omen for summer oil demand.

Will Saudi Arabia stabilise the market via an output cut? No. The Saudis do not want to risk global recession on eve of US election as the European debt crisis escalates. Brent crude now trades at its lowest level since January 2011.

The fate of oil prices is now a variable of Saudi output policy, Europe, global oil inventories and Iran geopolitics. Saudi Arabia has made it clear that it is willing to offset any Iran crude lost due to the July EU embargo as there was no diplomatic breakthrough in Moscow. The UK foreign secretary has publicly threatened to tighten Iran sanctions.

If Saudi Arabia cuts output, oil prices will soar since Opec is now overproducing into a crude oil glut. This is all the more true if Brent falls below $90, Saudi Arabia’s budget break -even price. The kingdom cannot implement a strong cut five months before a US election and amid a European sovereign debt crisis. So Iran and Russia will not succeed and Brent could well fall to $85. Prince Salman bin Abdulaziz, the eighth Saudi Crown Prince in the history of the kingdom, is among the most experienced statesmen in the Arab world. As Governor of Riyadh and Defence Minister, Prince Salman has earned the respect of the world’s captains and kings. The Al Saud family faces a volatile Arab world, vast social challenges and uncertain oil market. It will not risk a Brent crash in 2012.



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