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Business & Economy

Tough days ahead

The Gulf region has emerged as the only place with relative economic stability and potential for growth in the latest International Monetary Fund (IMF) World Economic Outlook, released earlier this month. But challenges remain.
In fact the latest forecast is by 0.4 percent lower than the previous prediction made in July. The IMF, however, expects the growth rate to accelerate to 3.9 percent next year, but again that is 0.9 percent slower than the July forecast.
Since oil was the main factor behind the relative economic stability witnessed by the Gulf region, it is the same oil market that is expected to enter into a period of turbulence in the coming few months that will have its impact on producing countries.
It remains to be seen whether the current softness in the oil market will turn into a price war because each member country is expected to fight for its market share.
If an oil price war resumes, it will not be the first. A price war ensued almost three decades ago —but that was under a different climate and conditions.
Then OPEC was committing itself to an official price. And in its attempt to defend that benchmark price, it first adopted a ceiling, followed later with quotas allocated to each member country.
Saudi Arabia, being the biggest producer within the organization, was given the role of the swing producer, which raises and lowers its output volume to adjust to market supply needs.
But, in reality, things did not work out as planned because most of member countries did not stick to their quota. But the Kingdom continued to lower its production at that time to help prop up the official OPEC price.
That exercise led at one point to North Sea oil production exceeding that of Saudi Arabia. This made the latter to warn its fellow members to stick to their assigned quotas or the Kingdom would follow suit and protect its own interests.
The warning was followed later by concrete steps such as changing the pricing formula adopted by OPEC. That was the move, which triggered the price war then.
Everyone was bleeding, but in such situations the determining factors are the ability to withstand losses in addition to flexibility in managing its oil industry.
Both are available in the Kingdom, which managed that price war till it came to rest, when OPEC decided later to go back to the role of managing the market though with less emphasis on defending prices and more on restoring the market share of other producers.
This led to a completely new turn where the main focus has shifted to ensuring market share. Over a period of 10 years, OPEC has managed to raise its market share by one million barrels a day (bpd) each year, but more importantly, the organization moved away from the pricing issue leaving it to market forces. Bit it still adjusts its production more or less on individual basis rather than collectively.
The current softness in the market places the organization at a crossroads: will it go back defend oil price or continue to its march to guard its market share. It could be difficult to come up with a clear cut answer, but it will be safe to say that things are not as they used to be when the first oil price war was waged three decades ago.
One main lesson learnt is that a drastic drop in oil prices furnishes the suitable environment for yet another pick-up in demand, which has to be satisfied with enough supplies.
However, falling income forces producing countries to cut into their investment and their ability to bring in more oil on-stream. And that sets the stage for future market tightness, resulting in high prices.
That situation makes even consumer countries to become unhappy because sustained low prices impact negatively on their consumption rationalization efforts. The issue also has an influence on spending for renewable and alternative energy schemes.
Moreover, a remarkable drop in price could easily jeopardize the shale oil boom and bring an end to that bonanza.
The US had a similar experience during the first price war.
It discovered the hard way that if its stripper wells that pump between 5,000 bpd and 10,000 bpd are closed because the operation became uneconomic, it would be difficult to reopen them again even if prices climbed up again.
Then Washington became one of those pushing for restoring some management to the oil market.

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