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◼ REMARKS Bloomberg Businessweek March 23, 2020When Brent crude, a global oil benchmark, opened for
trading on March 8, it plunged within seconds by more than
30%—the largest one-day price drop since the Gulf War in- In early January, Brent had briefly risen above $70 a bar-
rel; now, it’s fallen below $30.
The price plunge reverberated well beyond oil. It hit the
markets at a vulnerable time: Stocks had been rising for years,
and valuations were sky-high. Meanwhile, economic growth
looked wobbly in the face of the novel coronavirus. When
the price of petroleum plunged, it triggered a domino effect
across global equity and credit markets.
The Saudi shock-and-awe campaign was so brazen that
many took it as an attempt to impose maximum pain on
Russia. The aim, according to this theory, was to bring
Moscow back to the negotiating table.
The argument made sense: Why would Saudi Arabia want
to push oil prices down and keep them there? It’s true that
Riyadh would seem to have the advantage over Russia in a
price war, mostly thanks to its spare production capacity and
the world’s lowest production costs—less than $3 a barrel.
Russia can’t match Saudi Arabia’s ability to boost oil pro-
duction. But Moscow is much better at defense than the
Saudis are. Russian President Vladimir Putin used the last few
years to build a war chest of petrodollar reserves. At $577 bil-
lion, the cash pot is up 60% since 2015. Over the same period,
Saudi petrodollar savings have declined 28%, to $502 billion.
Moreover, Russia benefits from a floating exchange rate,
which absorbs part of the blow of low oil prices. Perhaps
more important, Russian society has already endured a few
tough years of U.S. sanctions: It can absorb more pain.
So far, the tactics aren’t prompting the Russians to seek
talks. The Kremlin has said it isn’t surprised by the fall in
prices and doesn’t see a need to meet with OPEC. That’s
partly because the price war is giving Moscow something it
wanted: It’s prompting U.S. shale companies to announce big
spending cuts. Rather than wait and see, as U.S. shale execu-
tives did when the Saudis tried to bankrupt them in 2014-16,
this time spending cuts “have been swifter than expected,”
says Brian Singer, a managing director at Goldman Sachs
Group Inc.
So why didn’t Saudi Arabia cut production to support
prices earlier and unilaterally? History provides some per-
spective on going it alone. For several years after the oil cri-
sis in 1979, then Saudi Arabia oil minister Sheikh Ahmed Zaki
Yamani, cut production unilaterally, with little help from oth-
ers at OPEC, to keep oil prices high, at about $34 a barrel. In
1985, with output plunging, Riyadh turned his policy around,
and soon after Yamani was fired.
Overnight, the kingdom boosted production significantly,
and oil prices collapsed almost 70% from November 1985 to
May 1986. When Riyadh made peace with its OPEC allies
about a year later, the group targeted a price of about half
what it had been before the Saudi production increase: $18 a
barrel. Except for a brief spike during the 1990-91 Gulf War,
it took 15 years for oil to trade again at its 1985 level of $34 a
barrel. Every Saudi oil minister since Yamani has promised
not to repeat his mistake of cutting production unilaterally.
Prince Abdulaziz is no different.
Once the Russians opened the floodgates in Vienna,
though, the Saudis opportunely jumped in. The kingdom has
ordered Aramco to boost production capacity to 13 million
barrels a day, up from 12 million. The expansion is a hugely
expensive commitment. When Aramco decided in 2004 to lift
output capacity to 12 million from 11 million, it spent six years
and billions of dollars working on the project. Khalid Al-Falih,
then Saudi energy minister, said in 2018 that lifting produc-
tion capacity by another million barrels would cost the king-
dom $20 billion to $30 billion.
It will also be difficult to reverse course. “As Saudi Arabia
increases its productive capacity, its willingness and ability
to cut production becomes more challenging, as no pro-
ducer wants to be operating well below its maximum sus-
tainable capacity,” Bassam Fattouh, director of the Oxford
Institute for Energy Studies, wrote in a research paper pub-
lished last year.
Riyadh is obsessed with an energy market that is being
shaped by the fight against climate change. Aramco, on the
prospectus for its 2019 initial public offering, warned that
oil demand might peak within 20 years. The Saudis may be
choosing a completely new strategy. As owners of a huge geo-
logical petroleum endowment, they could be moving to mon-
etize their reserves more quickly to avoid being stuck with a
rapidly depreciating asset. Energy scholars call it a “fast mon-
etization strategy,” and Saudi advisers have been discussing
it in private for some time.
The approach has advantages. It would secure a growing
share for Saudi crude, as higher cost producers are pushed
out of the market. Not just shale drillers, but even Big Oil,
which is already under pressure from shareholders to boost
profits, will have to cut spending on the development of new
wells and, therefore, supply. Lower oil prices could also slow
down the adoption of green technologies, particularly the
electric cars that Tesla Inc. and others are building.And if
SaudiArabiaandRussiacandriveenoughrivalsoutofbusi-
ness,perhapstheoilmarketwouldtightenagain.
But the monetization strategy also carries enormous risk.
Higher production, alongside weaker demand, is a certain
recipe for low prices. If the kingdom follows it, others in OPEC
will join, too, pushing even more crude into the market, fur-
ther depressing prices. Saudi Arabia can barely afford that.
According to the International Monetary Fund, Riyadh needs
an oil price of about $80 a barrel to balance its budget. More
important, its balance of payments only breaks even at about
$50 a barrel. Without higher prices, Saudi Arabia will start
to run large and sustained balance of payments deficits, put-
ting the peg between its currency, the riyal, and the U.S. dol-
lar at risk. Since he became de facto ruler of Saudi Arabia,
Mohammed bin Salman has made a number of risky eco-
nomic and political moves—the change of oil policy is one of
the riskiest yet. <BW>