- What King Abdullah's Passing Means For The Oil Markets
- Oil Crash Needs A Villain But The Story Is More Complex Than That
The death of Saudi Arabia's King Abdullah made international headlines on January 22, raising questions about the future of the Middle East. News of his death briefly rattled the oil markets, but the media attention paid to the event outstrips the significance: it is business as usual in the Arabian Peninsula.
The outpouring of praise for King Abduallah was bizarre. The Washington Post labeled him a "reformer," and The New York Times said he was a "force of moderation." U.S. Secretary of State John Kerry took to Twitter to pay his respects. "King Abdullah was a man of wisdom & vision. US has lost a friend & Kingdom of #SaudiArabia, Middle East, and world has lost a revered leader," he tweeted.
Sure, King Abdullah fought Al Qaeda and joined the World Trade Organization. But he also maintained an iron grip over his monarchy, a country in which women cannot legally drive and risk being beaten by religious police if they go out in public without facial covering.
So in many ways, King Abdullah was more of the same. And his successor, King Salman, will continue conservative geriatric leadership over his oil kingdom. This is evidenced by his speech earlier in the month, on behalf of the late King Abdullah, that Saudi Arabia will face the challenge posed by low oil prices with a "firm will."
But in reality, the question of what happens to Oil Minister Ali Al-Naimi – and with him, Saudi oil policy – was in some ways much more important than which specific successor takes the throne. For now, Al-Naimi appears set to stay on according to the AP, at least through OPEC's next meeting in June.
The Saudi government quickly assured the world that its oil policy will remain unchanged. The smooth succession and adherence to current policy calmed the oil markets, which saw prices retreat after briefly jumping by nearly 2 percent.
As a result, Saudi Arabia will continue its pursuit of market share – oil output will remain steady in the face of depressed prices.
The Saudi budget breaks even at somewhere around $63 per barrel, suggesting they will run a significant deficit this year. That is something the kingdom is willing to take on, given the $800 billion in cash reserves it has stashed away for a rainy day.
The November 2014 decision to maintain output, followed by the collapse in oil prices, fueled some rather triumphalist speculation about how U.S. shale killed off OPEC. Yet the strategy Saudi Arabia laid out in November, which will be continued by King Salman, demonstrates full well Saudi Arabia's influence over oil markets. As the only significant source of spare capacity in the world, it alone has the ability to voluntarily ramp up or down several million barrels of oil per day. For now, it is keeping the taps open, forcing a contraction from others.
And it has more staying power than U.S. shale producers. The number of active rigs in the U.S. fell by 209 between December and mid-January 2015. That is the fastest decline since data collection began by oil services firm Baker Hughes, dating back to 1987. Production cuts will eventually follow.
"Everyone tells us to cut. But I want to ask you, do we produce at higher cost or lower costs? Let's produce the lower cost oil first and then produce the higher cost," OPEC Secretary General Abdullah al-Badri said at the World Economic Forum in Davos.
Saudi Arabia is willing to wait out low prices. That means that the pain for U.S. shale producers should continue, and will likely grow worse before it gets better.
Claudio Descalzi, the CEO of Italian oil giant Eni, called on OPEC to cut oil production in order bring supply and demand into balance. "What we need is stability... OPEC is like the central bank for oil which must give stability to the oil prices to be able to invest in a regular way," he said in Davos, according to Reuters. Descalzi says that OPEC's failure to cut production could lead to oil prices skyrocketing to $200 because many private oil companies will push off drilling.
But that is exactly what Saudi policy could be aiming for: maintain market share, force others to cut back production, and reap the rewards of higher prices once they do.
Saudi Arabia's entire economy is based on oil. The government brings in 85 percent of its revenues from petroleum exports. Whether it is Abdullah or Salman, the Saudi royal family's preeminent concern is to ensure the longevity of its petrol kingdom. For now, that means no change in its current oil strategy.
By Nick Cunningham of Oilprice.com. Oilprice has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.