Saudi Arabia Takes Out Its Energy Weapon

The OPEC oil cartel made a surprising decision last fall to keep pumping oil into a market already awash in the black gold. On Friday in Vienna, they’ll almost certainly double down on that strategy.

Despite plenty of brave rhetoric from OPEC ministers this week, that’s less a reflection that the cartel is winning the oil wars than a recognition that its most powerful member, Saudi Arabia, is in a long-term fight to defend its privileged position — and take geopolitical rivals like Iran and Russia down a notch.

Ahead of the meeting, plenty of OPEC bigwigs have been talking up the success of their strategy, which was to drive oil prices down, squeeze high-cost producers like those in the growing U.S. oil patch, and maintain their share of a very lucrative market. Qatar’s oil minister said Wednesday he feels “optimistic” that global demand for oil is picking up again. And Saudi Arabia’s oil minister, Ali al-Naimi, told reporters on Monday that everything is just fine and that there’s no need for the cartel to trim production to prop up weak oil prices.

“Demand is picking up. Good! Supply is slowing, right? That is a fact,” he said, according to Reuters. “You can see that I’m not stressed, I’m happy.”

But in reality, OPEC countries and especially the world’s biggest exporter, Saudi Arabia, are coming to grips with the fact that they have not been able to kneecap rival oil producers by flooding the market with their own record levels of oil output. Oil prices have plunged by more than 50 percent since last summer, but U.S. output has actually kept rising: Oil production is up half a million barrels a day since OPEC’s Thanksgiving wager and is at its highest levels in almost 50 years. Russia, too, has kept pumping and is tickling post-Soviet highs of about 10.7 million barrels a day. That belies OPEC’s rosy visions.

“They’re whistling past the graveyard, to a certain extent,” said Bob McNally, president of the Rapidan Group, an energy consultancy. “This is a longer game than they thought it would be last fall. Notwithstanding all the happy talk in Vienna, we’re still in the staring-down phase of this contest.”

To be sure, lower oil prices have had some effect. Countries outside of OPEC, including the United States, added an extra 2.2 million barrels of oil per day in 2014, but are on track to add only half that this year, said energy analysts at Wood Mackenzie. At the same time, oil consumption is starting to pick up around the world after a dismal year in 2014. All that could slowly combine to balance the market and nudge prices up toward $70 a barrel next year, WoodMac said. Crude oil dipped to just under $60 a barrel in New York and $63.50 in London on Wednesday. At those prices, many companies — especially in the U.S. shale patch — feel that making high-cost investments in oil production doesn’t make economic sense.

Plenty of big oil producers, especially Venezuela, Iraq, Iran, and Russia, are desperate to see higher prices, since cheap oil is battering their economies and impacting their social welfare systems at home and their ability to influence events abroad. But none of them are willing to cut their own production to make that happen. Indeed, nearly all of them are pumping at near-record levels. Despite its struggles with the Islamic State, Iraq notched record levels of oil exports in May, at more than 3 million barrels a day.

Iranian officials, for their part, are still talking up their optimistic visions of pouring huge amounts of additional oil into the market if and when sanctions on Tehran are relaxed as part of the international negotiations over the country’s nuclear program. Iran’s oil minister on Wednesday said he expected other OPEC countries would make room for extra Iranian output.

That may be optimistic, given the enmity many Gulf states — particularly Saudi Arabia — feel towards Tehran, and the Saudis have made it clear they don’t want to shoulder the burden of production cuts on their own. Analysts expect OPEC to roll over its official output of about 30 million barrels a day at the big meeting on Friday. (Since it’s a cartel, with plenty of cheating, actual OPEC output is closer to 31 million barrels a day.)

Ultimately, by staying the course, Saudi Arabia is playing a game of chicken with those other big oil producers inside OPEC, as well as Russia, rather than trying to wreck the U.S. oil bonanza. Riyadh has hundreds of billions of dollars stashed away in reserve and can withstand lower prices for years if necessary; Iran, Iraq, and Russia don’t, and can’t.

As all three ramp up oil production, that threatens Saudi Arabia’s market dominance. At the same time, from a strategic point of view, Saudi leaders view all three countries as potential troublemakers at a particularly delicate time in the Middle East.

Iran is led by Shiite clerics deeply hostile to Sunni Saudi Arabia and its central place in the region; Iraq has had successive Shiite leaders and has moved closer to Iran in recent years. And Russia is causing problems in the Middle East by shipping advanced weapons to Saudi enemies like Syria and Iran. It’s also continuing to destabilize Europe, where it resumed hostilities in Ukraine on Wednesday. Once-skittish European officials now seem ready to renew energy sanctions on Russia for another six months, inadvertently helping Saudi Arabia in its ultimate aim of throttling Russian oil production.

“Iran, Iraq, and Russia are the real rivals,” McNally said. “There are commercial and geopolitical reasons for Saudi Arabia to worry about them.”

Photo credit: DIETER NAGL/AFP/Getty