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The ‘politics’ behind oil price fall

It is no longer a issue of whispering in the corridors of the oil industry. It is now part of public debate. Is Saudi Arabia launching an oil price war in tandem with the US to undermine or at least weaken energy dependent adversaries Russia and Iran?
The latest to join this discussion is the notable New York Times columnist Thomas Friedman, who wrote on Oct. 14 under the headline “Pump War?”
“One can’t say for sure whether the American-Saudi oil alliance is deliberate or a coincidence of interests, but, if it is explicit, then clearly we’re trying to do to President Vladimir Putin of Russia and Iran’s supreme leader, Ayatollah Ali Khamenei, exactly what the American and Saudi Arabia did to the last leaders of the Soviet Union: pump them to death — bankrupt them by bringing down the price of oil.”
It is no surprise that people try always to find a link between oil and politics.
After all the black gold got its description as a strategic commodity because more than 100 years ago, in 1911 to be exact, then minister of Britain’s admiralty young Winston Churchill made a remarkable decision to shift from coal to oil as a source of energy.
That decision was seen instrumental in securing victory for the Allies as well as securing the oil politico-economic affinity.
It was the Arab-Israeli war of 1973 and its fallout by the Arab oil embargo, then the Iranian revolution that have consolidated the relationship between oil and politics. Even the 1986 oil price war was given a political dimension and was seen as playing a considerable role in the collapse of the Soviet Union three years later.
However, the central and crucial point to remember is that in both cases now and back in 1986 the drop in oil prices is and was in fact a reaction to market realities and not a deliberate action to achieve certain political ends.
It was a different market then in 1986, when OPEC was adopting a strategy of defending an official bench market price.
Within that strategy, the Kingdom was given the role of the swing producer, who within 5 million barrels per day (bpd) allocation was to raise and reduce its output according to market needs. But the real performance showed that other OPEC members were not committed to their respective quotas. As a result the kingdom saw its market share dwindling to little over 2 million bpd, or less than what Britain used to pump then out of the North Sea.
That was the prime motive that pushed Riyadh to drop its commitment to the official OPEC price, adopt a more flexible and lucrative netback selling arrangement to attract customers and restore its market share.
That shift toward market share was adopted by the rest of OPEC, which led eventually and over time to double the organization’s market share to an average of 30 million bpd currently from 16 million bpd then.
The other significant shift was that the kingdom no longer plays officially the role of the swing producer, though it continues to raise its production and lower it as it sees fit according to a Riyadh sovereign decision, not an OPEC one.
Last year for instance it raised its production to record high of 10 million bpd, and then reduced it to 9.7 million bpd currently according to industry estimates.
Over the years the Kingdom has developed three main goals: the first was to adopt moderate pricing system that is in line with market realities with the goal of making consumers use oil as long as possible given the abundance of oil in the Kingdom’s reserves; also to have a spare production capacity ranging between 1-2 million bpd to compensate for any supply shortage and enhance the Kingdom’s strategic importance and finally to have enough income to enable it meet its domestic and foreign commitments and invest in maintaining and expanding its oil industry.
Though relationship between oil and politics can’t be ruled out completely, but Riyadh has made it very clear in number of occasions that it prefers separating the two. In fact OPEC meetings in the past few years became more like those conducted by private businesses in terms of its focus, and the short time it takes to make a decision in a one day meeting.
Like what happened back in 1986, this time also the drop in oil price is due to oversupply and the emphasis of Riyadh on its market share more than on defending any price, which it sees to reflect market realities.
The oversupply is due mainly to two things more production is coming from OPEC members despite the security and political instability plaguing some of OPEC countries, while the other is coming from a new source: that is the US and its fracturing technology that managed to raise US domestic production of oil and gas to its highest level in 28 years.
There are some reports to suggest that by the end of this month total US domestic production of oil and liquids will place the US is the biggest producer ahead of both the Kingdom and Russia.
This represents a qualitative shift that was made possible by the price of oil exceeding $80 a barrel, which was seen as a reasonable price that allows for making fracturing commercially viable.
According to this calculation even the US will be hurt if the oil price is to drop below $70 a barrel and may see its shale oil bonanza comes to an end. If history is any guide, one of those who urged Riyadh to call off the oil price war back in 1986 came from the US, who saw that many of its oil producing states had suffered by the steep drop then of oil prices.
The disaster was not only in the financial bleeding of those oil producing states, but many of them have what was known as stripper wells that bump between 5, 000 — 10, 000 bpd. And if such wells are closed because of the low prices, they would never be opened again.

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