Lessons forgotten with Saudi focus on the short term

One of the great myths in the oil world is that Saudi Arabia is the force for price moderation. The Saudis have played their role to perfection ever since the days of Sheikh Zaki Yamani, the urbane oil minister, in the 1970s.

The Saudis follow Theodore Roosevelt's advice to "speak softly and carry a big stick"; their stick being the world's largest oil reserves.

Conversely, the "price hawks", led by Iran and Venezuela, consistently trumpet the virtues of higher prices. In their view, the "fair price" is US$10 higher than whatever it is today. As in the old Texan expression "all hat and no cattle", they are content to talk big.

But actions speak louder than words. When prices crashed in late 2008 after the onset of the global downturn, it was the Saudis who took the lead in cutting supplies to restore prices.

More recently, Iran and Venezuela, along with most other Opec members, were pumping at capacity even before the outbreak of violence in Libya drove prices skywards. The kingdom, backed by Kuwait and Abu Dhabi, which usually follow its lead, increased production modestly to cover for lost Libyan output but did not make up all of the shortfall.

In recent years it has been Saudi Arabia that has raised production while most other Opec states have lagged behind. A mix of problems - war and insecurity, sanctions, mismanagement and incompetence, and ideological hostility to foreign investment - has prevented Iran, Kuwait, Nigeria, Iraq, Venezuela, Algeria and Libya from realising their potential.

They essentially surrendered their influence over oil markets to Riyadh. The result has been an ideal combination for Saudi Arabia: room to increase its production moderately, while prices remain high.

The Saudis plan their production to maximise revenues, not on the basis of altruism towards consumers or any philosophical devotion to moderate oil prices. In the 1980s, the lesson of trading off short-term for long-term gains was learnt the hard way - a lesson that now seems to have been forgotten.

An attempt to maintain prices well above market levels encouraged competing producers in the North Sea, Mexico and Alaska, at the same time as consumers were discovering the virtues of energy efficiency and alternative fuels.

The Saudis discovered that even by producing no oil at all they could not defend their preferred price. In 1986, the rigours of the market compelled them to boost output, triggering a decade and a half of slump in the market that hit them, and many other producers, very hard.

This points us to the lesson of habituation. Put simply, we all grow used to wealth. Given a substantial pay rise, we may save for a few months but the lure of a bigger house and a fancy car quickly becomes inescapable. What was once a luxury soon becomes a necessity.

Hydrocarbon-rich states, aiming to satisfy their subjects' material needs, face this dilemma continually. During the oil boom from 2000 onwards, Saudi Arabia managed to pay off its debts and accumulate substantial foreign reserves.

But the current turmoil in parts of the Middle East and North Africa region unnerved the House of Saud so much it committed some $129 billion (Dh473.81bn), almost half a year's oil earnings, to subsidies, housing, religious and military groups and other giveaways. The oil price Saudi Arabia now requires to balance its budget has risen from $68.50 a barrel to $84.

But just because the Saudis have stumbled into an economy that "needs" $84 a barrel does not mean they will get that price. Oil consumers are not a charity. In the short term, prices above $120 a barrel are clearly attainable.

But such levels are dangerous for the world economy, a lesson that should have been learnt from 2008. Record oil prices then were not the cause of the global downturn, but they influenced its timing.

In the longer term, new production is on its way from Iraq, Brazil, Kazakhstan, Canada, US shales and West Africa. China is cutting subsidies and there is strong interest in less fuel-hungry vehicles, hybrid and electric cars.

Trapped in the iron triangle of reduced economic growth, competing supplies and increasing efficiency, oil prices will eventually fall.

King Abdullah's spending spree has, in effect, raised the discount rate for Saudi Arabia - the factor by which it weighs present against future benefits. Revenues now have become more attractive compared with revenues in the future.

The implications are clear: lower oil supplies and higher prices today with a more painful correction down the road - a more volatile and cyclical oil market, and an even harder job of reform for Riyadh when the inevitable lean years return.

Robin Mills is an energy economist based in Dubai, and author of The Myth of the Oil Crisis and Capturing Carbon