"As oil prices have tumbled, one question has reverberated around the market: what is Saudi Arabia up to?
Little restraint has been shown by some energy market watchers in their commentary on the recent sell-off and the role played by Opec’s biggest producer. The 25 per cent fall in the price of Brent crude since mid-June, to almost four-year lows, they say, is the result of a deliberate strategy by the Gulf nation to test the mettle of rival producers from Russia, to fellow Opec member Iran and US shale producers.
By refusing to lower production significantly and by cutting export prices, Saudi Arabia has started a price war that it expects to win because of its cheaper cost of production and huge foreign exchange reserves.But cooler heads say Saudi Arabia’s recent actions are more nuanced and a reflection of market realities.
Prices have extended their rout into a fourth month, as high levels of production from North American shale formations has coincided with sustained output from Libya and Iraq, despite the bloodshed that has ravaged both countries. At the same time demand has slowed amid sluggish economic growth in Europe and Asia, creating a surplus.
With the current market scenario having crept up on Saudi Arabia, it has had two options: accept a period of lower prices in order to retain market share. Or, cut production and sacrifice market share in defence of higher oil prices. It seems to have taken the former.
"For the Saudis, cutting production significantly right now is suicidal. They are not going to fight such market movements,” says Nat Kern, president of Foreign Reports, a Washington-based consulting firm. "They could cut to stabilise the price at $100, but demand is weak, so they could then be in a position where they would have to cut again and again.”
Higher prices would only encourage more drilling from US shale groups and other high-cost producers. All the while, they would only continue to lose market share.
Remarks by Saudi officials to analysts in New York and London suggest the kingdom can withstand an extended period of lower prices and may be comfortable at $70 a barrel. This, they hope, will induce demand, curtail some supply and balance the market.
Already the price of Brent crude has bounced back a little to about $86 a barrel, from a low of roughy $83 last week. Traders are holding out for greater Chinese demand to support the price further.
"With prices hovering in the $80 to $90 range, they don’t feel the need to act,” adds Mr Kern. "But if the price fell a lot lower, to let’s say $60, then they would look to take action. But they don’t think they’ll drop that low.”
Sourced from the Financial Times at http://www.ft.com/cms/s/0/9ab77884-57cd-11e4-8493-00144feab7de.html#axzz3GarKwRwX