For a number of reasons, the first phase of the current down-cycle in oil prices and energy stocks promises to be less protracted than the supply-driven correction that occurred in the 1980s and 1990s.
Ali Al-Naimi, Saudi Arabia’s influential minister of petroleum and mineral resources, lived through the kingdom’s disastrous campaign to prop up oil prices by cutting production.
These hard lessons prompted Saudi Arabia to adopt more of a hands-off approach to the oil market. OPEC has also tended to act less cohesively relative to the 1970s and 1980s; for example, since 2008, the cartel has maintained a target for aggregate output, instead of setting quotas for each member.
Saudi Arabia has interceded on a few occasions to prevent oil prices from reaching levels that would accelerate demand destruction or threaten the global economy.
When oil prices spiked to more than $145 per barrel in summer 2008, Saudi Arabia brought some of its spare capacity onstream. Government officials also indicated that the country would develop new fields and expand its output over time to meet global demand.
Saudi Arabia likewise stepped up to the plate in early 2011, when civil war reduced Libya’s oil production to less than 100,000 barrels per day from almost 1.6 million barrels per day. To balance the market, Saudi Arabia tapped its spare capacity, ramping up its output to about 9.7 million barrels per day from 8.5 million barrels per day.
Most OPEC members have minimal spare capacity and rarely adjust their production as part of a concerted effort to influence prices; the 2 million barrels per day of oil output that Saudi Arabia can bring onstream relatively quickly accounts for 87 percent of the cartel’s effective spare capacity.
Though maligned by the US media, OPEC merely decided to maintain current production levels instead of ceding market share in an effort to manipulate prices—a decision that shocked pundits and investors who had forgotten the hard lessons Saudi Arabia learned in the early 1980s.
Readers often ask when Saudi Arabia’s ballooning budget deficits will force the country to cut output in an effort to bolster oil prices and its revenue. Some pundits have also speculated that Russia and Saudi Arabia will cut a deal to curtail their output and drive prices higher.
But the lessons from the past suggest that cutting production to bolster oil prices would merely extend Saudi Arabia’s pain, as the country would cede market share to non-OPEC producers.
Given the relatively short development times associated with US shale plays, Saudi Arabia eventually would find itself in facing the same dilemma of whether to maintain its output or cut production to shore up oil prices temporarily.
Rest assured, Saudi Arabia won’t choose to repeat the strategic errors of the early 1980s anytime soon. The country will bide its time and wait for lower oil prices to curtail higher-cost supply and stimulate demand.
The strategy appears to be working: Non-OPEC production is expected to fall sharply next year, while global oil demand has grown at the fastest pace in almost a decade. Despite this progress, these adjustments won’t take place overnight.
Once the world works through excess inventories of crude oil, WTI prices should recover to a level that incentivizes enough output to offset the global decline rate and meet demand.
Our medium-term outlook still calls for oil prices to remain lower for longer and range between $40 and $60 per barrel. However, as we’ve warned since the beginning of the year and throughout the spring recovery rally, weak seasonal demand could drive oil prices to about $30 per barrel later this year and/or in early 2016.
Because Saudi Arabia and OPEC have opted to maintain or even slightly increase their oil output, the adjustment process shouldn’t take as long as the one that stretched from 1986 into the early 1990s. We also disagree with sensationalist predictions for oil prices to hover around $50 per barrel through the end of 2029.
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Elliott and Roger on Dec. 30, 2021
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