December 2014 Commentary

What’s the Saudi Game?

by J. L. Granatstein

How does a manufacturer beat down his competitors? Flood the market with goods and sell them at a low price, hoping to drive competitors into the ground. That, in essence, is what Saudi Arabia is doing with its recent tactics with its oil. 

In the last few weeks, the Saudis refused to agree to the Organization of the Petroleum Exporting Countries (OPEC) cutting production as a way of dealing with an oil glut and falling prices. Then a few days ago, the Saudis’ state-owned oil company cut the price it charges for oil sales to Asia and the United States. These moves amount to classic cut-throat market tactics.

But there is more going on here. The Saudis are launching a preemptive strike at shale oil and oil sands production, in effect striking at Canada, the United States, and the European countries now seeking shale oil. Production from these unconventional sources is expensive, many fields requiring oil to sell for $100 a barrel to be economic. But the Saudis have successfully connived to drive the price of a barrel of oil down to the mid-$60s, and they have indicated that they do not expect the price to stabilize until it reaches $60 a barrel. 

Oil at that low price does not mean that the oil sands will stop producing, but it does indicate that exploration and drilling will decline substantially and that investors will back away before sinking hard cash into new ventures. The recent rout on Canadian stock markets, the hammering that our oil giants have taken, will likely continue. The same difficulties apply in spades to shale oil producers, drillers, and investors, and estimates are that American shale oil production will drop by a third. 

The lower prices at the pump are good for motorists, to be sure. But they are also manna from heaven for the environmentalists hoping to strangle the oil sands and shale oil production, along with pipeline projects. The opposition to such projects has been heartened, and Naomi Klein, the goddess of the anti-capitalist set, is already issuing pronunciamentos proclaiming coming victories.

The declining price of oil will hit Alberta and Canada hard, and the budget surpluses Finance minister Joe Oliver saw coming just a few weeks ago now seem chimerical. In late November, Premier Jim Prentice seemed to have everything under control, but no longer. Other nations will be hammered even harder—Iran, Nigeria, and Venezuela especially.

But so will Vladimir Putin’s Russia. His economy was doing well when oil was priced above $100 a barrel. But with the massive cut in oil prices and with Western sanctions because of his incursions into Ukraine starting to bite, Putin’s oligarchs are hurting and so are Russian state revenues. The ruble has plunged dramatically, and $1 Canadian today will buy almost 50 rubles. The NATO countries are not immune to the effects of the oil price drop, but compared to Moscow, they are and will remain in much better shape. President Obama, good environmentalist that he is, will worry about cheaper oil putting more cars on the road, but he will not be upset to see Putin’s Russia in deeper economic trouble. The domestic pressures are almost certain to force Putin to re-think his tactics and probably to put his aggressive moves on hold—for a time.

As for the Saudis, they sit firmly in the catbird seat. They can produce their oil cheaply, and they can keep pumping forever at the current low price. But like every other producer who starts a price war, the rich sheikhs in Riyadh will choose their time to jack their oil prices back up. That time will come when the oil sands development has stalled, the pipeline projects have run into even more difficulty, and new shale oil projects have ground to a halt. Cheap oil serves the Saudi purpose for now. But the longer game, as always, is for higher prices.

J.L. Granatstein is a Fellow of the Canadian Defence and Foreign Affairs Institute.

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