Abu Dhabi, UAEMonday 1 June 2020

What Saudi Arabia should say about its oil

Saudi Arabia has been criticised because of its refusal to adjust its production. It has its reasons, but they should be communicated better.
Ali Al Naimi has been Saudi Arabia’s oil minister since 1995. Tim Boyle / Bloomberg
Ali Al Naimi has been Saudi Arabia’s oil minister since 1995. Tim Boyle / Bloomberg

Saudi oil policy has generally been constructive in recent years. In 2007 and again in 2011, the Saudis rushed to add production when the market found itself short. And during the Great Recession, Opec cut production to support oil prices in the face of collapsing demand.

With the recent collapse of oil prices, however, the Saudi mission has become much harder. As a strategic matter, the Saudis were correct in allowing oil prices to fall without a production cut. Nevertheless, the pressure on the kingdom has been unrelenting, and the western press has pilloried the Saudis – and in particular Ali Al Naimi, the country’s oil minister since 1995 – as mean, heartless and inflexible.

One senses these criticisms sting the Saudis. They value their reputation as a responsible member of the oil community and take their role of Opec patriarch to heart. Consequently, the Saudis find it hard to say no.

Consultants such as myself confront such situations from time to time, when a client pushes us to approve a project unsupportable by the data. As a matter of client politics, saying no is often not a viable alternative.

But there is another approach. We can finesse the matter by laying out the conditions for approval, rather than refusing to go along. We might say, for example, “Building an additional tunnel from New Jersey to New York would be viable if rail passengers were willing to pay twice as much for their tickets”. This does not challenge the project, but rather clarifies the conditions for its success.

Such an approach to oil markets could be helpful to the Saudi decision-makers. Here is how I might present it on the minister’s behalf:

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Saudi Arabia has long been committed to stability in oil markets. We have added production when needed, in both 2007 and 2011. And we have cut production when warranted, as in 2009. We have not cut production now, not because of a lack of commitment to Opec, our allies, or the broader global economy, but because such cuts must be beneficial and meet a set of objective criteria. Let us detail these criteria here.

Any modification in Saudi production, either up or down, must be:

• Consistent with Saudi Arabia’s short-term interests

• Aligned with the kingdom’s long-term interests

• Supported by adequate market data

• Part of a coherent intervention plan

• And possible to be implemented in the time available

First, any production cut must be at least neutral with respect to Saudi Arabia’s oil revenue. Saudi Arabia can provide oil price stability, but it is not a charity. If a proposed production cut improves not only Opec’s but also the kingdom’s revenue position, then we will consider it.

Second, the kingdom must have an opportunity within 18 months to restore production to earlier levels without collapsing oil prices. We will not cut production merely to permanently lose market share. Therefore, we may consider a production cut if we have confidence that we will have a definite window to reinject volumes that were earlier withdrawn.

Third, we must have the data to be able to act. With rapidly changing production economics in US shales, at present no one can confidently assert the dollar cost of producing the marginal barrel of oil, either in the United States or globally. Therefore, we will act only when the data is sufficient.

Fourth, we must have an action plan in which we have confidence. That is, we must have reason to believe that any production adjustment, up or down, will lead to the targeted level of prices. We will not cut production unless we believe that the cut will raise prices to the level desired.

Fifth, we must consider the issue of time. Historically, the kingdom has found it easier to cut production than to add it. Obtaining data, building a consensus – and in the case of production additions, logistical preparations associated with producing and marketing incremental supply – take some time. Therefore, any decision should be assumed to require from several weeks to a few months, and we understand that in some cases this means we will act too late.

We have earlier stated that we would not cut production under any circumstances. This is too categorical a refusal. Saudi Arabia stands ready to adjust its production if this does not harm short and long-term Saudi interests and can be made with sufficient certainty in the time available.

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With this, Mr Al Naimi would externalise the logic of Saudi production decisions. He would be laying out a series of criteria that, at least to me, seem reasonable and defensible. The kingdom does not have to renounce its role as balancer of the oil system. Critically, Mr Al Naimi does not have to refuse the many outstretched hands. Rather, he can lay out a template to inform subsequent Opec discussions. These can focus on assessing the data, the action plans and the extent to which they meet the criteria. Rather than closing off dialogue, Mr Al Naimi could channel it. Of course, if the criteria are met, then Saudi Arabia will be under pressure to cut production – but then it would also be in the kingdom’s interest to do so.

Steven Kopits is the president of Princeton Energy Advisors.

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Updated: February 4, 2015 04:00 AM

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