Saudi Arabia plays a complicated game with oil prices

The recent sharp fall in oil prices shows a game within a game. Brent crude has lost nearly US$20 since June to fall below $100 a barrel, its lowest level for two years, even as Saudi Arabia cut 400,000 barrels per day from its production. The Saudis compete against non-Opec producers, while playing both with and against their Opec peers.

Saudi Arabia has a particularly complicated task at the moment. It firstly has to take the lead in deciding on a reasonable overall Opec production level. This never-ending question is one in which it is well versed in answering.

Economic weakness in China led a sharp slowdown in demand. US production was driven by shale to its highest level since 1986 this year, and is likely to beat its all-time high next year, with new deepwater production also on the way. The stronger dollar also puts pressure on the price.

Then Riyadh has to balance against other Opec members to maintain that target. Over the past three years this has been more difficult than usual, in a game featuring least three wild cards.

Libya's production is wildly variable month-by-month — it reached 870,000 barrels per day after recovering from blockades that reduced production to as low as 150,000 bpd, but last Wednesday output dropped again as rockets fell near the Zawiya refinery. With the country in political crisis, it seems only a matter of time before the struggle to control its oil facilities resumes in full.

Sanctions continue to keep a lid on Iran’s production, but with the November deadline for negotiations over its nuclear programme drawing near, 1 million bpd or so of Iranian oil could return to the market within a few months — or deadlock could make the crisis deepen.

Federal Iraqi and Kurdish exports may be set to gain with the formation of the government, a constructive attitude from the new oil minister, Adel Abdel Mahdi, and the military counter-offensive against the Islamic State (IS). Iraq has cut its production target to a still-optimistic 9 million bpd by 2020 — but even, say, 6 million bpd, from today’s 3 million bpd would take a big bite out of the share of other Opec members.

Supply and demand are not the only factors at work. The Saudis also have to consider wider political objectives. The United States looks to them to help maintain pressure on Iran by keeping oil prices moderate and providing customers with alternative supply. The Ukrainian crisis casts the shadow of a winter freeze over Europe. Now Riyadh is being roped in by the US to support a government in Baghdad it dislikes, against IS, the greater enemy.

Meanwhile, Opec is giving mixed messages. Kuwait, which usually follows the Saudi lead closely, increased production to 2.9 million bpd in September, and could raise it further to 3 million bpd in October. Both the Kuwaiti oil minister, Ali Saleh Al Omair, and the Opec secretary general, Abdalla Salem El Badri, said recently that they expected oil prices to rebound by the end of this year.

But Mr El Badri suggested Opec’s next scheduled meeting in November would cut its output target from 30 million bpd to 29.5 million bpd.

The Arabian Gulf countries should not worry too much about temporary price weakness. The IMF estimates the Saudi budget needs an oil price of about $91 per barrel to balance its budget, the UAE $73 and Kuwait $53. Large sovereign wealth funds can cushion any deficit. Much more exposed are Iran, Iraq, Russia and Venezuela.

But a long period of stagnant or falling prices is a concern. It may be better to allow prices to moderate now, rather than making deep production cuts in the hope of holding close to $100 per barrel. The wise card player knows to quit when ahead.

Robin Mills is the head of consulting at Manaar Energy and the author of The Myth of the Oil Crisis

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