Over the past few years, Saudi Arabia has clearly not done what’s required to restrain oil prices, assuming it cared or had the ability to do so. In fact, the Saudis actually produced a bit less oil in the second quarter of 2011 than they did in the third quarter of 2008. Part of this undoubtedly relates to production constraints which limit the Saudis’ ability to increase their oil output significantly higher than it is right now. In addition the Saudis have become increasingly more hawkish from a policy standpoint when it comes to oil prices. If this is the case, it represents a pivotal development not just for OPEC and not just for the future price of oil, but also for the global economy, which depends on the free flow of oil at reasonable prices (for years understood to mean $20-$30 per barrel). If the Saudis have become much more hawkish, whether by necessity, design, or a combination thereof it would mark a significant change for oil pricing down the road with significant implications for the world economy as well. This could even signal that we are now entering a new oil policy ballgame altogether – one where the players are not necessarily in the position they’ve grown accustomed to over many years.
Background
Beginning in the mid-1970s and during the years that followed, Saudi Arabia, as the de facto leader of OPEC generally worked to keep oil prices low normally in the $18-$22 per barrel range. Fearing that high oil prices could hurt global growth, reduce demand for Saudi oil by encouraging conservation and alternative energy development, with a fear to anger its US protector, Saudi Arabia-with a relatively small population compared to today that needed to be housed and fed-was generally able and willing to act as an oil price "dove." In May 2003, OPEC officials were proud to note that they were keeping the price of its oil "basket" at around $22-28 per barrel (roughly $25-31 on the New York Mercantile Exchange). During the first decade of the 21st century, OPEC did very well keeping prices in the $25-$30 per barrel range over most of 2000-2003 and around $42 per barrel in 2004. It is noted that this was during a period of the war with Iraq which many people erroneously point to as a major source of higher crude oil prices since 2003. That is simply not the case.
In fact, it wasn’t until 2005 when the price of oil began to drift upwards, hitting $57 per barrel in 2005 and $66 per barrel in 2006. In January 2007, when “light sweet” crude oil was at $55 per barrel, and June 2008, when it hit $134 per barrel, prices truly spiked with major world oil producers such as the Saudis either unwilling or unable to put more oil on the market to help get the situation under control.
This lack of action from January 2007 to early June 2008 represented a sharp break with past Saudi oil policy. It was particularly striking because of fears that oil prices above $100 per barrel could trigger a US and even global recession while concurrently encouraging a move away from oil through energy conservation and development of alternative energy sources. Even President Bush's very public attempts during this period to pressure the Saudis to raise oil production did not do much to affect Saudi behavior.
How can this puzzle of inaction during the January 2007 to early June 2008 period be explained? The answer is multifaceted. It suggests that we are in a new oil policy ballgame, one in which we cannot expect the Saudis to act as swing-producers in moderating oil price volatility and in keeping the world economy from oil-price-induced recession.
On a fundamental level, the Saudis simply may not feel there’s any good reason to look an oil gift horse in the mouth. Yet, whether or not the Saudis wanted or anticipated the oil price spike, it nonetheless turned into an enormous revenue windfall for a country that needed and continues to need it badly.
Why is this the case?
For starters, the population of Saudi Arabia has nearly tripled since 1980. This puts tremendous pressure on the government to provide Saudis with jobs, cheap food and housing, etc. At the same time Saudi real (inflation adjusted) per capita oil export revenue fell sharply, from a peak of about $23,000 per person in 1980 (in constant 2005 US$) to just $1,800 in 1998 and about $6,000 in 2006 and 2010 (about one quarter of the peak in 1980). In other words, the Saudis today need much higher crude oil prices in order to generate the revenue their burgeoning population requires. For Saudi Arabia, this is a vital security issue, as exploding populations of restless young people, chronic unemployment (and underemployment), political unrest, the rise of extremist groups like al Qaeda (not to mention Wahhabi radicals and other anti-regime elements within the Kingdom), and the reverberations from the “Arab Spring,” threaten domestic and regional stability. Given all these considerations, the need for Saudi oil export revenue is a great deal higher today than it was 10, 20, or 30 years ago.
In addition, regional concerns are also an incentive for the Saudis to move from an oil price "dove" to "hawk." At the strategic level, the Saudis have become more concerned about Iran in recent years. In part, this is because Saddam Hussein's strong Iraq – the counterweight to Iran in the Persian Gulf– is gone. In the absence of that counterweight, and with the Iranians apparently racing to build a nuclear capability, the Saudis have grown increasingly nervous. In addition to building up their own military forces and attempting to check Iran’s nuclear ambitions by diplomatic and other means, undoubtedly the Saudi leadership is looking to hedge its security by not antagonizing this large and powerful Persian neighbor.
One way of appeasing Iran, if that is indeed part of the Saudi strategy, would certainly be to avoid doing anything to lower oil prices, as Iran wants and needs major oil revenue to fund numerous domestic programs, including its nuclear program. At a minimum, the Saudis would be reluctant to take an active stand against Iran with regard to OPEC oil output (and pricing) decisions. Certainly, a Saudi strategy of pumping up production to lower oil prices wouldn't make the Iranian mullahs happy. Recall that Iraq invaded Kuwait in 1990 in part due to a dispute over the latter’s oil production and pricing policies.
Another angle
Another interesting angle is that, although Iran represents a greater threat to Saudi Arabia with the Iraq bulwark removed, Saddam Hussein's demise also makes the United States less critical to the Saudis overall. This is because the biggest threat to Saudi Arabia, in terms of a potential military invasion by ground forces, always came from Iraq not Iran. Of course, Iran poses the more serious ideological threat to the Saudis. Still, with Saddam gone, and with the Iraqi military threat removed for the foreseeable future, Riyadh needs the United States far less than it did in the 1990s. Given this shifting geopolitical calculus, the Saudis may very well feel less of a need to kowtow to Washington by increasing its oil production to lower global prices, and a lot more concerned with its own, more localized, security issues. In sum, the less the ground threat from Iraq-and today there is absolutely none- the less leverage the United States is likely to have regarding Saudi oil policy.
All of this does not mean that the Saudis have stopped counting on the United States in a wide range of security and economic areas. Further, it does not mean that Washington is without influence. To the contrary, the United States will remain the guarantor of regional Saudi security for some time to come. Still, a near-term reduction of US influence vis-a-vis the Saudis who have pressing needs of their own that outweigh any concerns over US displeasure does appear to have taken place in recent years despite Iran’s nuclear aspirations.
Meanwhile, just as the geopolitics of energy has shifted in the Persian Gulf, they have done so globally as well. With oil demand booming in Asia and elsewhere, and with the rising economic and military might of China, oil exporters like the Saudis have options that they didn't have in the past when it comes to customers as well as allies. Today, despite the fact that the world oil market is roughly global, the Chinese are more than willing to pay top dollar for oil, as well as to invest in oil projects in places like Iran and Sudan where the United States is reluctant to tread.
Yet another possible factor affecting Saudi oil policy are environmentally driven policies by some countries aimed at reducing greenhouse gas emissions and thus fossil fuel use. Added to oil security and economic concerns, environmental issues are pushing some oil consuming nations to reduce demand. Given the possibility, if not the likelihood, that consumers will start a long-term move away from oil and other fossil fuels, a mentality of "the future is now" may very well be developing in oil-rich countries. This would mark a stark contrast from the many years in which the Saudis assumed that a market would exist indefinitely for the massive oil reserves underneath their desert sands – thus the need to keep prices low enough to avoid development of alternatives and to keep their customers “hooked” on their product. Today though this calculus appears to have changed dramatically with a growing recognition that those reserves won't be worth much in the future if the world reduces the importance of oil through competitive fuels. Saudi Arabia and other OPEC members may very well be thinking a lot less long term these days, and a lot more along the lines of "cash in now, while the getting is good."
Even all these factors are not sufficient to explain the lack of action, as compared to the past, by the Saudis to increase oil output and to try to rein in oil prices in the 2008 period. It must be considered that they have less oil firepower to act as the long-term gasoline pump to the world than previously believed.
Changing forecasts
One piece of evidence comes from the US Energy Information Administration (EIA), which has sharply scaled back its medium-and long-term Saudi oil production forecasts in recent years. In 2000, for instance, the US Energy Information Administration (EIA) forecast for Saudi oil production capacity in 2010 was 14.7 million barrels per day. By 2007, EIA had slashed its forecast for 2010 Saudi oil production capacity to just 11.4 million barrels per day. That's a major reduction, especially when one considers that Saudi Arabia had always been the assumed "marginal producer" in OPEC, willing and able to increase output by millions of barrels a day to keep markets balanced at ‘reasonable’ prices. Today, that no longer appears to be the case. In addition to cutting its 2010 Saudi oil production forecast, the EIA also slashed its outlook for 2020 Saudi oil production capacity, from 22.1 million barrels per day in the 2000 International Energy Outlook, to just 14.5 million barrels per day in the 2006 International Energy Outlook (and to around 12-13 million barrels per day in the 2011 International Energy Outlook). That's a reduction of nearly 10 million barrels per day between the 2000 and 2011 International Energy Outlooks.
Other energy analysts appear to be reaching the same conclusion as the EIA. In its November 2008 World Energy Outlook, the authoritative International Energy Agency radically changed its long-term oil forecast. Until that report, the agency had dismissed notions that oil supplies might peak. To the contrary, the IEA saw energy demand growing briskly to 2030, with supplies adequate to meet demand, suggesting a peak significantly further down the road. In 2005, its executive director, Claude Mandil, even dismissed those who warned of this event as ‘doomsayers’. In contrast, in its November 2008 report the IEA significantly increased the assumed world oil production decline rate to 6.7% (from a 2007 assumption of a 3.7% per year decline rate). The IEA also forecast that the decline rate would increase to 8.6% by 2030. IEA chief economist Fatih Birol said in a 2009 interview that underinvestment was particularly becoming a serious problem, and that, as the IEA report asserted, a global oil peak is now expected around 2020.
Of course, modern technology may yet allow for major new oil discoveries or energy breakthroughs, such as have recently been seen with fracking and deep sea oil drilling technologies. Technology and human ingenuity do have a way of surprising us, especially when the profit incentive -in this case in the form of high oil prices- provides the motivation. In addition, high oil prices will continue to force changes in consumer habits. Energy efficiency, conservation and alternative energy developments may very well reduce oil demand growth in some countries, or even the absolute of oil demand, in coming years.
However for now global oil demand continues to rise, the global recession notwithstanding. Between 1998 - when oil prices bottomed out near $10 per barrel-and 2010, world oil consumption jumped by about 14 million barrels per day. That has taken it from 74 million barrels per day then to over 88 million barrels per day today. As the following graph illustrates, supply-demand realities have pushed up prices.
Since 2003 world oil consumption has increased by 9 million barrels per day while non-OPEC oil production has increased only 3 million barrels per day. As a result, OPEC has been forced to use much of its excess oil production "spare" capacity, pushing oil prices higher, as suggested by the following graph. This leaves us with what is close to a "vertical" supply curve in which higher oil prices do not result in higher oil output (as would normally be expected when profit opportunities arise). Given a vertical or near-vertical supply curve, any increase in world oil demand will likely result in a sharp increase in oil prices which is exactly what we've seen in recent years.
What is OPEC doing?
What is OPEC doing to meet rising world oil demand? Not enough. In fact, OPEC crude oil production has been stagnant or falling in recent years in the following countries: Algeria, Ecuador, Iran, Kuwait, Libya, Nigeria, Saudi Arabia, the UAE and Venezuela. Is there any reason to think this situation will turn around in the next few years? If that’s going to happen, then OPEC countries will need to invest significant amounts of money simply to offset the natural "decline rates" in existing fields. This becomes less likely as one considers the barriers to private oil company equity investment that exist in many OPEC nations. That’s certainly the case in Saudi Arabia.
Do the Saudis themselves see this as a problem? Perhaps not. Instead, they may have come to believe that the US and global economy can tolerate high oil prices. In fact, the Saudis made this very point to President Bush on his two trips to the Kingdom. On Bush's first trip in January 2008, they noted that the weakening US economy was a valid concern, but they remained reluctant to increase oil supply. In mid-May 2008, Bush visited the Kingdom once again, urging the Saudis to increase their oil output and even offering them help in developing a nuclear power program. Riyadh pledged to increase production, but only by a token amount. According to a White House press release, the world's largest oil producer did "not see enough demand from customers to increase oil production." To the contrary, the Saudis argued that they were already meeting world oil demand, and in fact had increased output by 300,000 barrels per day earlier that very month.
The bottom line is that the Saudis, in stark contrast to their behavior throughout the 1970s to the 1990s, today appear to have diminished their role as OPEC “swing producer” and the world’s main oil price “dove.” Today, as a result of combined oil production capacity constraints, economic, demographic and strategic pressures, and policy shifts, the Saudis appear to be acting more as a “hawk” than a “dove.” Whether this behavior continues, and whether we are or we are not on the cusp of a new oil paradigm, it is certainly striking that the Saudis have been so passive in the face of oil prices spiking from their traditional $20-$30 per barrel range to around $100 per barrel today. This lack of action represents an apparent break from past Saudi oil policy and needs to be studied much more carefully. If the Saudis have, indeed, moved firmly from “dove” to “hawk,” this would mark a significant paradigm shift with regards to global oil markets and energy security. It's a shift that should give the United States even more incentive to hasten its efforts to break our "oil addiction" once and for all.
Contributor Steve Yetiv is a Professor of Political Science at Old Dominion University in the United States. He is the author of The Petroleum Triangle (2011) and Crude Awakenings: Global Oil Security and American Foreign Policy (2004). Contributor Lowell Feld worked for 17 years for the US Department of Energy as a Senior Analyst.