Producing Oil: Speculation, Risk and Uncertain Rewards
Saudi Arabia’s economy is being severely impacted by the global overproduction of oil and it has so far been unable to counter the effects of diminishing demand. The OPEC group is pursuing risky strategies while also seeking alternative economic paths to maintain GDP growth. Recent developments such as the shale oil boom in the U.S. and slower economic growth in China have contributed to an increase in supply and a decrease in projected demand of oil, leading to a sudden price decrease. This change has been significant, with oil prices going from a high of $115 per barrel last year to a more than 50% decrease that reflects current low energy prices.
Instead of decreasing production to lower supply and therefore increase prices, Saudi Arabia and many of the Gulf States are increasing it. In doing so, they hope to maintain low enough prices for a sufficient period of time to make it impossible for their competitors, such as U.S. shale producers, to maintain their current production levels.
The International Monetary Fund has expressed concern that the effects of the artificially high oil production have spun out of control, with prices dropping much lower than anticipated. It is currently unclear whether Saudi Arabia, which relies on oil exports for 80 percent of its budget revenues, can sustain production without making major cuts to other parts of its economy.
The Saudis had estimated that their increased production would cause prices to drop to no lower than $80 dollars per barrel, still giving them a sufficient revenue margin to outlast their non-OPEC competitors. After the prices dropped to half that value, it seems that OPEC is harming itself as much as it is harming its competition.
The IMF recently warned that Saudi Arabia could use up its entire financial reserves within 5 years unless its undergoes major budget cuts or benefits from oil prices returning to their pre-2014 levels of more than $100 per barrel.
The newest development in Saudi energy policy, while not directly impacting its oil production levels, is perhaps a reflection that the OPEC leader is growing more concerned of the effects of low oil prices. Saudi Arabia released a pledge for the UN Paris talks to cut its carbon emissions by 130 million tons a year by 2030. It plans to achieve this goal through a combination of increased investments in renewable energy and the adoption of energy efficiency measures to reduce its consumption in fossil fuels. The ensuing economic diversification that would occur in the country will be sure to counteract at least in part the potentially enduring low oil prices.
Despite these issues, the Saudi Kingdom has not indicated a change in its production levels, maintaining its confidence in an eventual price increase. It is now a question of whether it, its neighbors, and the rest of OPEC can survive on their current financial reserves and increased austerity until this price change occurs.