Saudi Arabia bets its future on 'Berlin or Bust' oil strategy
World's largest oil exporter is forcing prices lower to win back market share but the high-risk strategy will test the house of Saud like never before
Saudi Arabia has won the opening battle of its radical oil strategy by forcing prices lower. But the kingdom is about to enter into a dangerous new phase in its war to regain control of the world’s oil market.
In November, Saudi succeeded in bullying the other members of the Organisation of Petroleum Exporting Countries (Opec) into continuing to pump their current quota of 30m barrels per day (bpd) as its first objective. The strategy born in the palaces of Riyadh has sparked the apparently desired oil price rout, which the kingdom’s veteran oil minister Ali Naimi clearly believes is necessary to shut down the cartel’s biggest rivals in Russia and the shale oil fields of Dakota.
Oil equals political power and influence for Saudi Arabia and a seat at the table of the world’s most powerful nations at the G20. Despite the colossal risks, something had to be done to reverse the tilt towards high-cost production coming from the US and elsewhere to maintain Saudi Arabia’s dominance as the so called global “swing producer”. With 13pc of global oil reserves and the cheapest production costs, the kingdom believes that it can still buy back the market and secure higher prices over the long term.
“This is one of the most important policy initiatives by Saudi Arabia in the modern era,” said Edmund O’Sullivan, an expert on the kingdom with Middle East Economic Digest and author of the book, The New Gulf. “It isn’t without risks but they have the political power and economic resources to pull it off.”
If victorious, Saudi Arabia will emerge stronger after re-asserting its global significance as the custodian of the world’s primary energy source. And, in pushing oil prices lower over the short term, it will reinforce its strategic importance to the US by bringing Russia’s President Vladimir Putin to his knees and putting pressure on Iran.
However, with the price of crude now in complete freefall, will Mr Naimi have the nerve to see through his high-risk strategy to the bitter end? It is bound to cause havoc among the economies of the Gulf Co-operation Council (GCC) states including the United Arab Emirates, Qatar, Oman, Kuwait and Bahrain. With the exception of impoverished Bahrain, all these countries depend on oil revenues to fill their government coffers and prop up their hereditary monarchies.
Brent crude closed the year at just over $56 per barrel, down 50pc from its peak in 2014 but Mr Naimi has gone on the record to say that, even if prices fall as low as $20 per barrel, the kingdom will continue to keep its vast low-cost oil wells pumping at their current rate of about 9.5m bpd. Some Opec insiders worry that Saudi is more likely to quietly increase its production by a further 1m bpd, causing an even sharper fall in prices. At these levels, what might be seen as the kingdom’s “Berlin or Bust” strategy - with echoes of the final all-out push to defeat Germany in the First World War - risks crippling not just the kingdom’s economy but also those of its close Arab allies.
The consequences of failure for Mr Naimi and Saudi Arabia are profound. During the last decade of relatively high oil prices, Saudi has amassed a $750bn war chest of foreign currency reserves that will be burned through quickly by propping up the shortfall in export revenues. Influential figures within the kingdom such as Prince Alwaleed bin Talal – the Middle East’s wealthiest individual investor – have already been an outspoken critic of Mr Naimi’s plan, which he says could have catastrophic consequences for the Saudi economy.
For the time-being at least, the kingdom intends to draw on its reserves to cover any shortfalls and actually expects to increase government spending by billions of dollars in 2015 next year despite a sharp drop in revenues from oil. Income is forecast to drop to 715bn riyals (£122bn) in 2015, from 855bn in 2014, leaving a deficit of 145bn riyals. However, that is provided that oil prices average $60 per barrel, whereas many experts are now forecasting crude could even touch the lows of $20 per barrel last seen in the late 90s.
Burning away its only cash reserves could prove unwise should the current slide in oil prices become entrenched. Over the longer term, a more fundamental slowdown in demand growth for crude and the improvement in green technologies such as electric cars could mean Saudi will never be able to re-establish its hoard of foreign currency held by the central bank.
Turning 80 this year, Mr Naimi’s own position as oil minister could also be questioned, should his gambit fail. Coming from humble origins in the kingdom’s oil-rich Eastern Province, much of Mr Naimi’s current power stems from the close support that he enjoys from the country’s ruler, King Abdullah bin Abdul-Aziz al-Saud. Keeping oil fixed at around $100 per barrel was thought to have been vital for both men.
The 91-year-old monarch has ruled the world’s most powerful oil producing state through some of its toughest years since the House of Saud first came to power over 100 years ago with the rise of his warrior Bedouin father, Ibn Saud. The Arab Spring uprisings, which took hold across the region in 2010, caught King Abdullah off his guard, as did the American government's willingness to stand on the side lines and watch Hosni Mubarak’s brutal regime crumble in Egypt.
Suddenly, with the Bush family out of the White House, Saudi Arabia was in danger of losing its influence in Washington’s corridors along with its grip on its own immediate surroundings in the Middle East. Although those political fires have largely died down, Mr Naimi is still taking a massive risk in launching a global oil price war – that he denies is politically motivated – at a time when Islamic State militants still pose a significant risk to stability in the region.
News that the ailing King Abdullah was taken into hospital on the last day of 2014 could have direct consequences for Mr Naimi, restricting his freedom to shape Saudi oil policy. Were the king to suddenly pass away, an ensuing power struggle in Riyadh against a backdrop of low oil prices could force Mr Naimi into a dramatic reversal.
Saudi Arabia is not alone in the GCC when it comes to royal succession worries. In the UAE, the current ruler Sheikh Khalifa is recovering from a stroke, while in Oman, Sultan Qaboos remains too weak to return to the country after travelling to Germany for medical treatment last summer. In both cases, the transition of leadership could make these states review their support of Saudi Arabia’s current strategy.
Mr Naimi will come under intense pressure over the next three months as the effect of lower oil prices starts to be felt throughout Opec and the wider global economy. However, for those countries like Saudi Arabia that are fighting for control of the world’s primary energy source, the pain is just beginning.
World's largest oil exporter is forcing prices lower to win back market share but the high-risk strategy will test the house of Saud like never before
Saudi Arabia has won the opening battle of its radical oil strategy by forcing prices lower. But the kingdom is about to enter into a dangerous new phase in its war to regain control of the world’s oil market.
In November, Saudi succeeded in bullying the other members of the Organisation of Petroleum Exporting Countries (Opec) into continuing to pump their current quota of 30m barrels per day (bpd) as its first objective. The strategy born in the palaces of Riyadh has sparked the apparently desired oil price rout, which the kingdom’s veteran oil minister Ali Naimi clearly believes is necessary to shut down the cartel’s biggest rivals in Russia and the shale oil fields of Dakota.
Oil equals political power and influence for Saudi Arabia and a seat at the table of the world’s most powerful nations at the G20. Despite the colossal risks, something had to be done to reverse the tilt towards high-cost production coming from the US and elsewhere to maintain Saudi Arabia’s dominance as the so called global “swing producer”. With 13pc of global oil reserves and the cheapest production costs, the kingdom believes that it can still buy back the market and secure higher prices over the long term.
“This is one of the most important policy initiatives by Saudi Arabia in the modern era,” said Edmund O’Sullivan, an expert on the kingdom with Middle East Economic Digest and author of the book, The New Gulf. “It isn’t without risks but they have the political power and economic resources to pull it off.”
If victorious, Saudi Arabia will emerge stronger after re-asserting its global significance as the custodian of the world’s primary energy source. And, in pushing oil prices lower over the short term, it will reinforce its strategic importance to the US by bringing Russia’s President Vladimir Putin to his knees and putting pressure on Iran.
However, with the price of crude now in complete freefall, will Mr Naimi have the nerve to see through his high-risk strategy to the bitter end? It is bound to cause havoc among the economies of the Gulf Co-operation Council (GCC) states including the United Arab Emirates, Qatar, Oman, Kuwait and Bahrain. With the exception of impoverished Bahrain, all these countries depend on oil revenues to fill their government coffers and prop up their hereditary monarchies.
Brent crude closed the year at just over $56 per barrel, down 50pc from its peak in 2014 but Mr Naimi has gone on the record to say that, even if prices fall as low as $20 per barrel, the kingdom will continue to keep its vast low-cost oil wells pumping at their current rate of about 9.5m bpd. Some Opec insiders worry that Saudi is more likely to quietly increase its production by a further 1m bpd, causing an even sharper fall in prices. At these levels, what might be seen as the kingdom’s “Berlin or Bust” strategy - with echoes of the final all-out push to defeat Germany in the First World War - risks crippling not just the kingdom’s economy but also those of its close Arab allies.
The consequences of failure for Mr Naimi and Saudi Arabia are profound. During the last decade of relatively high oil prices, Saudi has amassed a $750bn war chest of foreign currency reserves that will be burned through quickly by propping up the shortfall in export revenues. Influential figures within the kingdom such as Prince Alwaleed bin Talal – the Middle East’s wealthiest individual investor – have already been an outspoken critic of Mr Naimi’s plan, which he says could have catastrophic consequences for the Saudi economy.
For the time-being at least, the kingdom intends to draw on its reserves to cover any shortfalls and actually expects to increase government spending by billions of dollars in 2015 next year despite a sharp drop in revenues from oil. Income is forecast to drop to 715bn riyals (£122bn) in 2015, from 855bn in 2014, leaving a deficit of 145bn riyals. However, that is provided that oil prices average $60 per barrel, whereas many experts are now forecasting crude could even touch the lows of $20 per barrel last seen in the late 90s.
Burning away its only cash reserves could prove unwise should the current slide in oil prices become entrenched. Over the longer term, a more fundamental slowdown in demand growth for crude and the improvement in green technologies such as electric cars could mean Saudi will never be able to re-establish its hoard of foreign currency held by the central bank.
Turning 80 this year, Mr Naimi’s own position as oil minister could also be questioned, should his gambit fail. Coming from humble origins in the kingdom’s oil-rich Eastern Province, much of Mr Naimi’s current power stems from the close support that he enjoys from the country’s ruler, King Abdullah bin Abdul-Aziz al-Saud. Keeping oil fixed at around $100 per barrel was thought to have been vital for both men.
The 91-year-old monarch has ruled the world’s most powerful oil producing state through some of its toughest years since the House of Saud first came to power over 100 years ago with the rise of his warrior Bedouin father, Ibn Saud. The Arab Spring uprisings, which took hold across the region in 2010, caught King Abdullah off his guard, as did the American government's willingness to stand on the side lines and watch Hosni Mubarak’s brutal regime crumble in Egypt.
Suddenly, with the Bush family out of the White House, Saudi Arabia was in danger of losing its influence in Washington’s corridors along with its grip on its own immediate surroundings in the Middle East. Although those political fires have largely died down, Mr Naimi is still taking a massive risk in launching a global oil price war – that he denies is politically motivated – at a time when Islamic State militants still pose a significant risk to stability in the region.
News that the ailing King Abdullah was taken into hospital on the last day of 2014 could have direct consequences for Mr Naimi, restricting his freedom to shape Saudi oil policy. Were the king to suddenly pass away, an ensuing power struggle in Riyadh against a backdrop of low oil prices could force Mr Naimi into a dramatic reversal.
Saudi Arabia is not alone in the GCC when it comes to royal succession worries. In the UAE, the current ruler Sheikh Khalifa is recovering from a stroke, while in Oman, Sultan Qaboos remains too weak to return to the country after travelling to Germany for medical treatment last summer. In both cases, the transition of leadership could make these states review their support of Saudi Arabia’s current strategy.
Mr Naimi will come under intense pressure over the next three months as the effect of lower oil prices starts to be felt throughout Opec and the wider global economy. However, for those countries like Saudi Arabia that are fighting for control of the world’s primary energy source, the pain is just beginning.
