OPEC is worried about cheaper oil. Why isn’t Saudi Arabia?

at 04:30 PM ET, 06/13/2012

Right now, the world is pumping more oil than it needs. That means falling prices: good for oil consumers in the U.S. and Europe, bad for producers in the Middle East. So when OPEC meets Thursday, some oil states like Iraq will ask the cartel to throttle output and push prices back up.


Cheaper oil for everyone! (FAHAD SHADEED - REUTERS)
But Saudi Arabia, the world’s largest oil producer, appears to be okay with letting prices fall further — even below their current price of $96 per barrel. At first glance, that might seem odd. Shouldn’t the Saudis want sky-high prices? Wouldn’t that mean more money for them? Perhaps. Yet according to energy economist Philip Verleger, the Saudis have all sorts of subtle reasons for wanting prices to ease up further — from punishing Iran and Russia to staving off America’s quest for oil independence.

The first thing to note, Verleger explained in a phone interview, is that Saudi Arabia is most concerned about two countries — Iran and Russia. Iran’s nuclear program is causing other Middle Eastern governments to sweat uncomfortably. And the Saudi king recently suggested, in a rare rebuke, that he was unhappy with Russia’s veto of a U.N. resolution to curtail the violence in nearby Syria.

Both Iran and Russia are major oil producers. And their economies would be hurt by lower crude prices. Many analysts believe that Iran needs oil prices well above $100 per barrel to balance its budget. That gives Saudi Arabia a lot of leverage. “The Saudis know that lower prices are a much better way to put pressure on Iran than sanctions,” says Verleger.

Second, Saudi Arabia is a member of the G-20 and wants to stay in the good graces of the United States and Europe. So, Verleger says, the Saudis may want to let prices drop further — even below their current, still-historically-high level of $96 per barrel — to provide further economic stimulus to the rest of the world. “The Saudis believe that letting prices fall 50 percent in 1999 helped the world recover from the Asian debt crisis,” Verleger says.

Third, Verleger says, the Saudis are casting a wary eye on the nascent shale-drilling boom in the United State and Canada. “Some of those [North American] producers are very sensitive to the price of oil,” he says, “so if the Saudis let oil prices keep falling, that will slow production.” Saudi Arabia is none too keen on other countries developing their own sources of oil anytime soon.

Those three reasons may help explain why Saudi Arabia recently called for a higher target for OPEC’s crude output — even though prices are already dropping. Saudi production has driven the recent boom in oil supply, cranking out 9.9 million barrels per day in May, its highest level all year. Because of its gargantuan reserves, Saudi Arabia can still play a major role in determining the price of crude, at least when demand is slack. If the Saudis decided to cut back their output — as happened after the financial crisis in 2009 — they could put a floor on prices. But they seem to have little interest in doing so for the time being.

Other OPEC countries, particularly Iran, Russia, Venezuela and Iraq may not like this state of affairs. “But there’s not much they can do about it,” Verleger says. “The Saudis run the show.”

Related: Over at FT Alphaville, Kate MacKenzie has more on Verleger’s analysis.

Related: For first time in years, the world is producing more oil than it needs.

 
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