It’s all but decided that the Organization of Petroleum Exporting Countries and Russia will extend their so-called “production cuts” at Thursday’s meeting in Vienna. It’s clear, however, that the play has been a mistake for Saudi Arabia, which initiated it. It should have stuck with the policies of its former oil minister, wise Ali Al-Naimi, who had driven down the price of oil in 2014 and put the U.S. shale industry through the wringer.
Naimi’s bold move was a bid to regain market share for OPEC. The Saudis were worried about the U.S.’s growing share of global oil exports, as Middle Eastern nations including Saudi Arabia decreased in importance.
Naimi saw the danger inherent in the U.S. shale oil development. Eventually, the U.S. companies would grab even more of the market, and prices would eventually drop because of the emergence of these new, bold players. So the Saudis tried to preempt this. They increased production and offered deep discounts to clients. In late 2014, prices plummeted. Oil-dependent nations, including Gulf states, Nigeria, Venezuela and Russia, had to pump like crazy to compensate for the loss of export revenue.
In 2015, the traditional oil exporters gained little because U.S. shale oil companies had hedged against the price risk. The price drop was costly for Saudi Arabia, which faced a fiscal deficit and shrinking international reserves. There was probably pressure on Naimi, but he stuck to his guns, ruling out any production cuts. And it began to work.
Global investment in oil exploration and production shrank some 23 percent in 2016, but North America saw a 38 percent decline. Credit became hard to come by. Since the beginning of 2015, 123 North American oil companies with almost $80 billion of debt filed for bankruptcy. Between June 2015 and July 2016, U.S. oil production shrank 12 percent.
The shale industry survived by driving down cost and innovating. But its wings had been clipped; it had to be more careful in future planning.
Naimi, however, retired in May 2016, and his successor Khalid Al-Falih almost immediately signaled a U-turn. The Saudi royals, including deputy crown prince Mohammad bin Salman Al Saud, were too impatient to continue the oil war. They sought an output-cutting deal with other large oil-producing states to drive the oil price higher. Though such a deal was reached, and the price rose, the effect could only be short-lived.
Firstly, the Saudis’ important negotiating partner, Russia, cheated. It had ratcheted up production to an unsustainably high level as the cuts were negotiated so it could just go back to normal output once the time came to cut. At the same time, Russia moved to take market share away from Saudi Arabia in one of its top export markets, China. This year, Russia is the top exporter to that country, displacing the Saudis.
As expected, not all OPEC members reduced output by as much as they’d promised. Iraq, the United Arab Emirates, Algeria and Venezuela missed their targets by a considerable amount. So while the Saudis and the Russians managed to talk up the oil price for a while, traders later were underwhelmed by the hard data.
They also couldn’t fail to notice rising oil inventories in the U.S., where the shale industry reacted vigorously to OPEC’s retreat. U.S. oil production is again approaching record levels. Some of the bankrupt producers are back, riding a new wave of optimism. And U.S. exports are up dramatically, competing with OPEC and Russia in every market, including China.
What Naimi feared is now happening, and it would be harder and costlier for OPEC to hold back the trend if it decided to boost production again now. It won’t try, however: Instead of playing a long game, the Saudis have chosen to reap the benefits of moderate oil prices today, patching up the kingdom’s budget and trying to invest in the diversification of its economy. It’s a weak position; even if President Donald Trump, a major fan of the U.S. oil industry, bowed slightly as he accepted Saudi Arabia’s highest civilian award last week, the Saudis are essentially acquiescing to a U.S. conquest of their traditional markets and to the loss of their role as the only power capable of balancing the oil market.
Naimi’s price war is often called an expensive miscalculation. But I would argue that leadership in the global oil market, and a stable market share, was more important to Saudi Arabia than the income it lost during Naimi’s gamble — about one-third of the $2 trillion lost by OPEC. It will be decades until the country sheds its oil dependence, even if its monopolized, overregulated economy can move fast on diversification. If it hung on for another year, maybe two, shale would have sustained bigger losses, and the investment drought could have had lasting consequences. Saudi Arabia would have retained a substantial degree of control over prices and faced less competition in key markets. But it gave up, and the nine-month extension of the production cuts, which will probably be agreed on Thursday, will further undermine its position, though perhaps keeping the oil price above $50 a barrel a little longer.
Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.