Exclusive Opinion Piece : Has Saudi Arabia abandoned its role as a Swing Producer?, Asks Manish Vaid

Given its own economic conditions and plans for upcoming Saudi Aramco’s IPO next year Saudi Arabia cannot escape its role as swing producer, even though unwittingly.

Exclusive Opinion Piece : Has Saudi Arabia abandoned its role as a Swing Producer?, Asks Manish Vaid

By Manish Vaid (*)

Oil prices have once again entered a bearish trend despite short-term bounces resulting from record compliance of the Organization of the Petroleum Exporting Countries (OPEC) deal. The relentless production of U.S. shale, supported with increase oil production by Iran and Iraq has pushed oil prices low.

Besides, resilient U.S. shale output, sluggish demand from American drivers, which have kept U.S. stockpiles at historically high levels, besides ongoing economic rebalancing efforts in China has further constrained oil consumption growth, putting tremendous pressure on the OPEC. Consequently, Saudi Arabia and Russia has signaled oil cuts extension into 2018 in the 172nd (Ordinary) OPEC Meeting on May 25, 2017 in Vienna.

OPEC deal, which helped oil prices to stay in the range of $50-$55 a barrel is now edging close to $45-$47 a barrel. On May 4, 2017, Brent prices for the future contract closed at $48.38 per barrel, the lowest since November 29, 2016, a day before the OPEC’s last meeting, while U.S. benchmark crude closed at $45.52 a barrel.

Amidst these developments, the biggest question, which arises, is that if Saudi Arabia still assumes a ‘Swing Producer’ tag. A swing producer is one that changes its crude output to meet fluctuations in demand and Saudi Arabia has so far played this role to an extent.

In this regard, the sharp drop in the oil prices between since mid-June 2014 has once again turned world’s attention to Saudi Arabia’s role as a swing producer, particularly after a visible shift in its oil policy.

However, the 166th ordinary meeting of OPEC in Vienna on November 27, 2014, which is seeing as the most important meeting since its historical meeting in late 1973, decided not to manage supply in the market to support falling oil prices, thereby signaling that there was no swing producer to the rescue this time. This was against the conventional wisdom that OPEC will continue to manipulate prices by tinkering with its own supplies.

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The biggest reason, which prompted Saudi Arabia to work unprecedentedly and against the conventional wisdom, was the fear that even if they cut the production to deal with recent spell of falling oil prices since June 2014, the same would have been offset by an increase in production from within and outside OPEC, without a significant impact on oil prices.

Moreover, during this period Saudi Arabia also wanted to have their stronghold in fast growing Asian market amidst presence of West Africa and Latin America exporters, who of late have shifted their markets to Asia after U.S.’s shale boom, which was no more dependent on these regions. To consolidate its position in Asia, Saudi Arabia also offered discounts for its Asian buyers, thereby striving to increase its market share irrespective of the oil prices trends. In an attempt to grab larger market share, Saudi Arabia were also competing with the U.S. shale oil producers, which were relentlessly producing shale oil.

Thus, for OPEC, market share strategy became the preferred option. Such strategy was largely driven by slower global oil demand, greater high-cost oil production (particularly from shale), reduced cohesiveness within OPEC and higher output in other non-OPEC countries, resulting in further drop in the oil prices, which even touched the lowest point since 2003, settling at $26.21 a barrel in February 2016.

Such market strategy premised on OPEC having low costs and U.S. shale having high costs and hence even succeeded in driving out high-cost U.S. shale producers, significantly as reflected from their falling rig counts and filing of bankruptcy by many of these shale companies.

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However, Saudi Arabia’s hope of keeping U.S. shale industry at bay, short-lived. Despite the fall in shale output, improved drilling and well efficiency helped these shale companies to survive, which continue to produce fewer oil. This helped in bringing down breakeven point by many shale companies and in some case matching and even going below the current prices of oil benchmarks. Consequently, these companies started to pump more oil and gas for less money.

Therefore, the fear, which stopped Saudi Arabia to freeze production during its 166th meeting in November 2014, has now become a reality and its shift in oil price strategy seemingly backfired.

This unprecedented attempt by Saudi Arabia of continuing with its oil production in a low oil price scenario, led to a belief for many experts that it has apparently abandoned the role of ‘swing producer’ in favour of U.S. shale producers. U.S. shale operators, with their unabated shale oil production were now able to respond rapidly in global oil supply, with quick adjustments to their production. Moreover, shale oil industry, with its unique cost structure and short business cycle, may undermine longer-term investment in high-cost traditional oilfields, which could offer less leeway for Saudi Arabia to play around its conventional role of balancing oil markets.

But even as ‘swing producer’ tag was apparently being surrendered by Saudi Arabia, in November 2014 allowing to shift the burden of balancing the market on to others, while sticking to maintain their market share, they have actually retuned to intervene the markets to arrest the fall in oil prices with OPEC deal.  Saudi Arabia has therefore, though inadvertently, has re-accepted the role of swing producer. This step of Saudi Arabia is largely been seen to support  oil-based economy and its attempt to create an environment for better valuation of Saudi Aramco’s initial public offering (IPO), scheduled for January 2018 as this needs an oil prices which is above $50 a barrel.

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U.S. on the other hand, have done well to abstain itself to assume the role of swing producer so far. Instead, the objective of the U.S. is to optimize its shale boom, which they started by lifting 40-year-old oil export ban to strive to become energy independent country, creating more jobs, enhancing its economic growth and energy security, besides creating additional source of revenues. U.S. President Donald Trump’s new energy plans has been a catalyst to meet this objective, thereby putting significant pressure on the Saudi Arabia led OPEC countries to intervene.

Therefore, given its own economic conditions and plans for upcoming Saudi Aramco’s IPO next year Saudi Arabia cannot escape its role as swing producer, even though unwittingly.

(*) — Manish Vaid is a Junior Fellow with the Observer Research Foundation, researching oil and gas sector and geopolitics.

Disclaimer: The views expressed in this article are those of the author.

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