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Saudi Arabia faces dire challenges: a burgeoning population that lives off of oil, and a growing royal family that lives extravagantly off of oil. The country is now running budget deficits, and otherwise is clearly living beyond its current means
…the Saudi’s hope is to stave off the day when they are the [political] disruptor of the Middle East…
So Saudi Arabia would like production cutbacks to drive up prices. What does the logic of cartels suggest will happen?
First, real-time data on OPEC production do not exist. That’s because cheating is rampant, and countries understate actual production. Scan the news and you’ll find stories galore on both the lack of data and (given that constraint!) the likely magnitude of cheating. After all, Saudi Arabia is not alone in finding itself squeezed between low oil prices and bedrock. Small producers pay lip service to the cartel, but in practice are selling all they can pump.
What of Saudi Arabia themselves? They currently pump about 1 in 8 barrels of oil, that is, 10 million of a global 80 million barrels per day. (OPEC pumps 42% officially, a bit more in reality.) So if Saudi Arabia cuts output 10% or 1 million barrels, global output falls 1.2%. Price does respond to demand, but even if it’s quite inelastic (0.3) that means price will go up by less than 5%. Hence Saudi revenue would fall 5%. Or more. So they simply cannot afford to cut output.
The greater the extent that others are capable of boosting output on the margin (think drillers in the US), the worse off the Saudis would be. (At present, for example, the US is sitting on record high inventories. As interest rates rise, that will pressure those “long” in the market to sell. A Saudi-induced bump in prices would accelerate that process, to the detriment of the Saudis.)
That doesn’t mean prices will necessarily remain low. Demand can change for a variety of reasons, and supply is subject to political disruptions. The Saudi’s hope is to stave off the day when they are the disruptor.
3 Comments
I did recently read on the news that OPEC has agreed to a short term deal to curb production in the short term, and it is a quasi agreement. Saudi Arabia also did try to exert monopoly like behavior on US oil last year right, and the US quickly responded by laying out the full extent of its oil inventory power, forcing Saudi Arabia to rethink their oil position? I also read recently that Aramco (world’s biggest oil company) is planning for an IPO in the next year, which is expected to be the biggest IPO of all time with potential valuation of $100B (even surpassing Alibaba’s IPO 2014 as much as 4 times). The country’s sole wealth generation through oil is definitely a cause for concern in both the short and long run.
The Saudi government has always financed the majority of the economic activity and wealth creation in the government through the massive amounts of oil revenue it has luckily been able to collect. However, as Professor Smitka described above, this model is in danger due to sustained lower prices and increased global supply. The government will seriously have to consider a kickback in its spending which could cause a massive economic downturn. This is dangerous because as citizens become poorer, Muslim extremism could begin to take hold of the mostly secular country.
This is a really interesting point. I wonder how the media is in Saudi Arabia. If it is fair and unbiased, which is a huge “if” considering the rampant cheating and collusion that already takes place there, then I hope the people place the blame in the government instead of The West. Only time will tell I suppose.
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