











Riyadh, Saudi Arabia

Only a congenital optimist would greet Shell’s abandonment of its Canadian and Alaskan projects – after sinking a combined $4.6 billion – with anything but dread. When even a supermajor is reporting quarterly losses of $7.4 billion, observers would be in their rights to throw up their hands in frustration and ask when will it end. The problem is indefinite, and WTI remains anchored around $45 per bbl for now, although it may or may not have bottomed out.

The supply glut persists. While North American rig counts and capital budgets have been declining for months, there are two factors contributing to current inventory levels: 1) some projects have realized cost reductions to the point where they are at least breaking even and 2) even where capital budgets are reduced, the effects on inventory levels will lag since it takes a few months for well declines to make their impact felt on overall supply levels.

The North American industry is actually a diffuse array of private sector players, operating diverse asset bases with different economics. By contrast, Saudi Arabia, the other swing producer, is a monolithic actor. By virtue of this, and because its decision to flood the markets is the immediate cause of today’s travails, Saudi motivations are key to understanding how prices got to where they are and ultimately under what circumstances they will rebound.

From the North American perspective, the assumption is that Saudi actions are a means to claw back market share from upstart shale producers. This is not necessarily false, but it stands to reason that the Saudis have other, more local motivations as well.

It is significant that the Kingdom is suffering under this self-imposed financial strain – just recently, the Emir of Kano and former Central Bank of Nigeria governor Muhammad Sanusi II pointed out that Saudi Arabia plans to dispose of $70 billion in assets – and that despite this it has chosen to soldier on.

“This is a mistake the Saudis have made before. In the 1970s and 1980s they created an oil glut and… oil prices came down to $10 dollars, $15 dollars a barrel and everybody suffered for that… It does not help them and it does not help anyone,” Emir Muhammad Sanusi II said.

It has already been pointed out that Saudi Arabia has a host of growing domestic and international problems, so despite its substantial assets and cash reserves, there is a limit on how much of its wealth it can utilize and what fiscal policies it can pursue. To claim otherwise is to ignore the costly systems of patronage that the Kingdom’s stability hinges on.

Consider that Saudi Arabia’s decision has undermined OPEC solidarity, costing oil producers like Iraq, Libya, Nigeria, and Venezuela billions in revenues, at a time when many of these countries are either mired in civil unrest or incredibly poor. Consider Saudi Arabia’s own financial costs. That this notoriously cautious Kingdom is taking such a politically and financially costly gamble implies that there is more at work here than simply retaining market share.

The answer may lie in geopolitics, which is inevitably tainted with a heavy dose of sectarianism when talking about the Middle East. Put simply, Iran is out of the cold, having struck a nuclear agreement with the United States in return for sanction relief. Per Saudi calculations, that may mean a potential 1.0 mmbbl per day of Iranian crude reaching markets once sanctions are lifted, in addition to Iraqi output currently at 740 mbbl per day. With Iran viewed as the predominant global Shia power and with Iraq seen as a Shia satellite due to the inclinations of the government in Baghdad, it stands to reason that Sunni Saudi Arabia’s seemingly desperate and self-defeating behaviour has a certain internal logic.

On one hand, the Kingdom may fear a US-Iran rapprochement, leaving Saudi Arabia isolated. On the other, the Kingdom shares Israel’s belief that Iran will not adhere to the nuclear agreement and that instead it will surreptitiously develop a nuclear arsenal. Taking into account Saudi Arabia’s profligate defense spending and foreign meddling, it stands to reason that the Kingdom believes itself to be in the midst of a security crisis, again coloured by the sectarian hatred and distrust that governs international relations in that part of the world.

The goal then must be to sacrifice earnings in the near term in the hopes that Iran’s greater resurgence is undermined by low oil prices. In this sense, then, the Saudi plan would actually hinge on US supplies holding steady long enough to allow Saudi Arabia’s geopolitical goals to be met. These include some arrangement in Syria and Yemen that leave Sunni-aligned powers in place or that at least check Iranian influence.

There is no way Saudi Arabia has not accounted for an eventual increase in prices following a drop in US shale supplies. If the focus was to harm North American shale producers to retain “market share,” it would seem a fool’s errand. After all, rebounding prices would inevitably attract new investment into previously uneconomic projects. It is doubtful that shale oil will remain in the ground for fear of future Saudi retaliation. Were it otherwise, then effectively the Saudis have committed to play an indefinite game of whack-a-mole with their US rivals, being ready to step in and take the fiscal burdens every time US production surges. This seems unlikely. Additionally, the argument for North American market share appears strained. Even as US dependence on Middle Eastern oil wanes, Asian markets are only set to grow. What Saudi Arabia loses in one market, it can gain in another.

The bottom line is that the market share argument is flawed because prices will inevitably rise, either because of supply reductions or surges in demand. That also implies that whatever brake the supply glut puts on Iran’s recovery is only temporary. However, that is not inconsistent with checking Iran. The Saudi strategy may simply be a gambit to buy time. Considering that Iran is an economically diversified, highly-educated country with more than twice the population and the potential to reach a genuine understanding with the West, a delay tactic may be the best the Saudis can hope for. Increased market share may be an incidental – and fleeting – benefit of this strategy, and it is consistent with the geopolitical end goal, i.e. undermining Iran. But it is not the primary motivation. Low oil prices may simply be a means to position Saudi Arabia and Sunni power more favourably should the Kingdom’s fears come true.