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Money Matters

Saudi Arabia’s balancing act with the price of oil

By Web Desk
Mon, 05, 18

For Saudi Arabia, the rebound in the oil price over the past year has been a strategic triumph. Its diplomacy, including an entente with longstanding rival Russia, led to a late 2016 agreement between Opec and other large producers, restricting oil supply. The deal has supported the steady ascent of prices since last summer. Brent crude hit $75 a barrel last month, and is now at a level that will enable Saudi Arabia to cover government spending from tax revenues, after three years of belt-tightening.

For Saudi Arabia, the rebound in the oil price over the past year has been a strategic triumph. Its diplomacy, including an entente with longstanding rival Russia, led to a late 2016 agreement between Opec and other large producers, restricting oil supply. The deal has supported the steady ascent of prices since last summer. Brent crude hit $75 a barrel last month, and is now at a level that will enable Saudi Arabia to cover government spending from tax revenues, after three years of belt-tightening.

Oil producers should remember, however, that victory can sow the seeds of defeat. If prices are allowed to continue to rise, it would be damaging for the world economy — and ultimately counterproductive for producers, too.

Crude has been driven higher by a combination of restricted supply, strong demand and international tension, with concerns about the future of the international agreement on Iran’s nuclear programme coming into focus most recently.

Supply restrictions have been partly intentional and partly involuntary. Venezuela, where mismanagement and a deepening financial crisis have driven production down by about a third since early 2016, has been an unwilling champion of Opec’s restraint.

With healthy global growth driving a strong increase in demand, the glut that sent prices lower in 2014-16 has been drained away, laying a foundation for prices to rise.

So far, so good. At about $75, oil is at a level that many producers and consumers will find tolerable. There have been reports, however, that Saudi Arabia may be tempted to push its luck. Last month, Reuters reported that in closed-door briefings Saudi officials had been suggesting they would be happy to see oil at $80 or even $100 a barrel, in part to help pep up the planned flotation of Saudi Aramco.

Allowing oil to rise that far would be a mistake. The IMF said in its World Economic Outlook last month that rising oil prices had not prompted downward revisions to growth forecasts, but that view was based on an assumption that crude will average about $62 this year and drop to about $58 next year. If prices are substantially higher, the impact on growth could be much more severe.

In the longer term, a higher oil price will encourage consumers to use less, giving a fillip to sales of electric vehicles and more fuel-efficient cars. The US is heading for a battle between state and federal governments over the Trump administration’s attempt to scrap a planned tightening of fuel economy standards. Increased fuel costs will strengthen the hand of those who argue that the standards should be retained because they create savings for consumers.

Higher prices also stimulate investment in oil supply, not least in the US shale industry, which is already running white hot. A shortage of pipelines, particularly at the heart of the boom in west Texas, will be a constraint on growth, but new capacity is being built and the longer prices stay high, the more investment will come.

The situation is given an added edge by the uncertainty over President Donald Trump’s decision on the Iran deal. If the US withdraws, that would mean new sanctions that could take some Iranian oil off the market — and heightened international tensions as the US seeks other means to obstruct Iran’s nuclear ambitions.

After achieving so much success in driving oil prices up, Saudi Arabia and its allies should now be giving serious attention to the prospect of having to hold them down.