Saudi Arabia - joining the dots: Part 4 - The price wars, defending market share

Saudi Arabia - joining the dots is a series of blog entries exploring Saudi Arabia's role in the oil markets with a brief look at the history of the royal family and politics that dictate and influence the Kingdom's oil policy.

Part 4 - The price wars, defending market share

The sudden fall in the oil price in the middle of 2014 and the subsequent lack of response by OPEC is a stark reminder of its members' policy of defending market share, although the cartel may openly deny it .

Forgotten in recent years and beyond recollection for those who are still young, the 1980s was the last time Saudi Arabia demonstrated its significant power in the oil markets in its efforts to defend market share. In hindsight, one questions whether Saudi emerged victorious from that war and whether it was worth fighting.

In the early 1980s, oil prices fell to record lows after hitting highs in the 1970s. Consumers (namely the US) vowed to reduce reliance of on oil given the high prices and actively implemented policy to switch to substitute energy sources, such as coal for power generation. 

In an effort to shore up oil prices caused by falling demand, Saudi urged its fellow OPEC members to cut production. Saudi cut its own production by c.80% to 3.5mmbbl/d, but many of the other members refused to follow suit. Saudi was furious as by taking action, it had lost out on revenue and market share. In retaliation to the non-compliers, Saudi ramped up production to full capacity and flooded the market with crude. The excess production caused oil prices to slump to c.USD7/bbl and it was another 20 years, before oil price began to recover to pre 1980 levels.

That part of history continues to haunt Saudi today and one can see its remnants in Saudi's stern policy of maintaining production, communicated to the world in that all important OPEC meeting on 27 November 2014.

Luckily for Saudi, and other OPEC members, its low cost of production (<USD20/bbl) means that production remains profitable even at USD50/bbl oil price. The current price war will see much production around the world being choked with high cost North American unconventionals and mature North Sea production being hurt.

Whether Saudi still holds (or wishes to hold) its nominated role of swing producer is a key question to ask. For now, it still has the ability to retrench production, but its low cost production base will mean it can withstand lower oil prices for longer whereas its non-OPEC counterparts will fall over one-by-one unless prices rebound in the near future.