Making Sense of OPEC’s Reasons for Lowering Oil Prices

Middle East Policy Council

The precipitous and sustained drop in oil prices and the unwillingness of the OPEC countries to cut down oil production to stem that fall has led to a spirited debate in the region on the possible reasons for the price drop. Many observers have also commented on the rational for OPEC’s insistence on keeping the current oil production output stable. The general consensus on the possible impact of the drop in prices in the region’s economies is that the Gulf countries can hold out a bit longer even if the oil prices stay at the current rate, despite ongoing discussions in Jordan about revisiting the already approved budget. Others have tried to offer various explanations for OPEC’s inaction, including the possible targeting of Iran by Saudi Arabia. In the end, it could very well be that rather than being a question of naked geopolitics, the drop in prices could be an attempt to price out of production oil’s biggest competitor, i.e. the exploration of new energy resources.

Writing for Asharq Alawsat, Salman Aldossary suggests that considering the pressure put on regional economies by the falling oil prices, one would expect the region’s governments to restructure their budgets. However, that is unlikely to happen: “With the expected decline in prices next month and dwindling demand, the Saudi government should clearly and explicitly announce its strategy for 2015. There are questions it should answer: how it intends to tackle the continuing decline in price and deal with the government’s allocations for future projects….Saudi Arabia and the Gulf states have been late in creating their own economic models which move their economies away from a dependence on oil. Despite all the assurances and promises of the five-year plans that—year after year—have evaporated along with the general budget statements, oil remains in reality the cornerstone of state revenues. The private sector remains underdeveloped while the government continues to be the main source of economic activity. The government is the biggest supporter of this formula, despite being the most affected by it. Imagine that!”

Arab News’ Linda Heard believes that the current dynamics should not be a cause of concern and that regional leaders and their citizens should keep their cool and not “Panic over oil prices…. Stock markets in the Middle East and the Gulf are being driven down by panic-selling by investors fearing budget cuts due to lower oil revenues, forcing the postponement of government infrastructure projects or reductions in subsidies. This bearish mood is driven by sentiment and has little relation to fact….Falling prices at the pump benefit consumers and the specter of inflation is being held at bay. But US authorities are taking a very short-term view. Should cheap oil hit the economies of America’s trading partners in a major way, US exporters will feel the pinch and jobs will be lost. Another factor keeping prices low is increased production by Iraq and Libya….We’ve yet to see which side of this complex conundrum will blink first as oil jitters are beginning to rattle global bourses. OPEC has the cure. It wants non-OPEC producers, such as Russia, Mexico, Venezuela, Norway, the US and Canada, to sit around the table with OPEC member states to agree on a way forward vis-à-vis cuts in production.”

Not only should investors remain calm, but if anything, the drop in oil prices could be a boon for businesses in the region. At least that is the argument put forward by Khalaf Ahmad Al Habtoor, an Emirati businessman, who in an op-ed for Arab Times argues: “The fact is that cheaper oil is an absolute benefit to humanity but unfortunately, investors are falling for warnings from scaremongering pundits, who speak from a purely academic perspective, and are negatively reacting to what should be good news….Investors in the Gulf shouldn’t listen to negative sentiment. This area is one of the World’s wealthiest. It is politically stable and our leaders have their hands firmly on the rudder. They know how to steer us through choppy waters especially after learning lessons from the 2008 global downturn which occurred through no fault of our own. Credit must go to Saudi Arabia, the United Arab Emirates and other GCC countries, which stood firm against various OPEC member states keen to diminish oil production in order to generate a hike in prices in response to political or economic pressures. Gulf leaderships are not reactive in a kneejerk fashion; they carefully study the big picture and weigh pros and cons over the long term, which is why our area has enjoyed phenomenal economic success.”

Not all countries and commentators are reacting with the same level of equanimity as the previous contributors would have us believe. In Jordan, for example, the Jordan Times reports that “In the wake of the steep slide in oil prices, the Lower House’s Finance Committee will have to decide how to weigh in this drop in energy cost before it takes a decision on the Cabinet’s proposed state budget for next year. Committee members are thus calling on the Cabinet to revise its budget for 2015, taking into consideration the lower than factored price tag for energy….Readjusting the oil price base from its current $100 a barrel to about $60 would also constitute a big gain for the government that should be taken into account in the called-for process of adjusting the budget for next year. The catch is in whether oil prices will stay at the current low levels. There is no sure way of knowing whether they could slide even more or reverse course and go up instead.”

On the other hand, Al Arabiya’s Camelia Entekhabi-Fard suggests that the “oil plunge” has been a mitigating factor in the ongoing negotiations over the Iranian nuclear program, driving home the need for a long-term solution: “The falling oil prices are hurting Iran which already has a limited quota due to embargoes, but interestingly, the falling prices are also negatively affecting the United States. Saudi Arabia, for its part, refused to reduce production for reasons of its own….If the price of oil continues to drop, the U.S. ambition of becoming the world’s biggest oil producer will not be achieved due to the high cost of production….In this highly politicized oil market, Iran and the U.S. resumed the nuclear talks in Geneva on Monday with a bilateral meeting. They will be joined by the P5+1 (five members of the U.N. Security Council plus Germany) on Wednesday. In November, the negotiation period was extended for seven months in the hope that a deal would be reached. With the danger of falling oil prices at the back of their minds, the U.S. and Iran could feel compelled to settle talks faster. So, if there is any oil production battle going on between the United States, Russia and Saudi Arabia, the bottom-line is that the main beneficiary is Iran.”

That is not a universally held view though. As an op-ed by Tehran Times’ Mahdi Ebrahimi explains the possible political motivations that the Saudis might have for not cutting oil production: “The Iranian oil minister has said, “Iran will supply oil according to the prices of the international market and has no plan to enter a price war that has been started by the Saudis”, but Saudi Petroleum Minister Ali al-Naimi believes that Aramco’s recent series of crude price cuts were in line with “sound marketing procedures” and should not be seen as evidence of a price war….The Rouhani government is drafting a new incentive mechanism for investment by international oil firms to overcome disincentives that drove many of them away during the Ahmadinejad presidency. If these incentives are effective, Iran can increase its production capacity up to 4 to 4.5 million b/d by 2016. Therefore, any reduction in oil prices by its competitors may negatively affect possible investments in Iran’s oil industry or weaken Iran’s position in the oil market….Are Saudis seeking to lower oil prices to put economic pressure on Iran?”

A similar argument about the political nature of OPEC’s decision to keep the current production levels is made by the Gulf News editorial staff with regards to the impact that the oil prices are having on the Russian economy: “If there was ever any doubt that the Russian economy is now on the brink of near collapse, look no further than the emergency decision by the central bank there to raise interest rates by 6.5 percentage points to 17 per cent….Energy resource dependent, the economy is contracting and the sharp decline in revenues is making it difficult for government officials to prevent the economy from implosion….In the long term, though, the central bank simply can’t afford to use its reserves to prop up the rouble — nor can it sustain and justify keeping the punitive 17 per cent rate in place. 
Russia’s pain is about to get whole lot worse— oil is still in free fall.”

Even though such explanations might be attractive, Al Arabiya’s Afshin Molavi points out that the real reason for OPEC’s policy of lower oil prices could have less to do with punishing Russia and Iran, and more to do with pricing out of business shale production facilities that may pose a long- term challenge to oil producing countries: “There is a larger play here than Iran or Russia. So, is it U.S. shale oil? Is the play to let the price drop squeeze out U.S. shale oil producers who need a higher global price to make their projects sustainable?… But will U.S. oil radically transform global energy markets over the next decade or two? The answer is no….The real question is: Will the U.S. fracking revolution expand globally? If it does, that could have a truly transformational effect on global energy. That would be the game changer….the OPEC decision to let the market find its own price makes sense. After all, a world of Chinese and Indian fracking would pose tremendous challenges to OPEC producers. So, this is not a fight between OPEC and U.S. shale oil. It’s a battle between OPEC and future shale. Because what is most dangerous to the future of OPEC is not U.S. production, but a world in which China, India and Europe all begin their own fracking revolution.”

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