Saudi Arabia’s Oil Price Manipulation

There’s a long running joke in my family that my sister and I learnt to count by playing card games.

At our place, that’s what we did on rainy days and wintery nights. Some families played Monopoly; we had the card game 500.

Most matches kept my sister and I up well past our bedtime. The teams were always different. The competition fierce. And no one was ever the champion long enough to gloat.

I bring up cards, because watching the failing oil price — or more specifically Saudi Arabia’s government fiddle with the oil price — feels a lot like an over confident card player calling ’10 hearts’ during a game of 500.

If you haven’t played or heard of the game, Wikipedia gives a most succinct description.

As the name suggest, the goal is to be the first team to reach 500. Each suit attracts different points, with clubs being the lowest and hearts the highest.

So claiming ‘10 hearts’ means your hand should be unbeatable. However, you only want to call 10 hearts if you have all the face cards, the joker and the highest numbered cards.

By calling out 10 hearts, you’re essentially telling the table you’ve won the game before it starts. So you better have the hand to back it up.

Having the best hearts in the deck doesn’t mean you’ll win. But if you play the cards right, there’s a darn good chance you will.

Saudi Arabia calls out ‘10 hearts’ at OPEC

After topping out at around US$115 in the middle of last year, oil began falling mid-July.

The fall turned into a plummet from September to October, though the plunge slowed during the lead up to the OPEC meeting in November.

As you can see from the chart below, the OPEC meeting came and went, and the oil price nosedived from around $85 per barrel to around $50.

Light Sweet Crude Oil Index

Source: / Diggers & Drillers

Click to enlarge

From the peak in June, to just before the November OPEC meeting, the oil price fell 27%.

Because of this fall, many analysts expected OPEC would cut production from the current 30 million barrels per day. The idea was that if the supply of oil reduced it might stimulate demand and raise prices along the way.

You know – the cure for low prices is low prices.

Instead, OPEC didn’t cut oil production.

And that sent the oil price into a freefall. It’s tumbled another 38% in a little over two months.

In fact, since oil’s peak in June, the oil price has more than halved.

So how does this relate to a card game?

I reckon Saudi Arabia is calling 10 hearts.

The Saudi government are telling the world they hold all the winning cards.

Another way of looking at is the Saudis will do what they want with oil production. And the price of oil doesn’t matter.

It can do this, because Saudi Arabia is the most influential member of the OPEC group.

Out of all the OPEC members, they have the second highest proven reserves at 265.8 billion barrels of recoverable oil. Beaten by Venezuela with 298.4 billion barrels of recoverable reserves.

However, the Saudi economy is much more stable than the South American member. And because of extensive investment, the Saudi Kingdom is capable of pumping out 12.5 million barrels of oil each day. It currently produces around 11 million.

The next OPEC members who come close are Venezuela and Kuwait. Both of these two barely get out 2.5 million barrels per day.

Knowing this, the OPEC move was not a rational market decision.

No, OPEC kept the current production rate as the Saudi board members encouraged them to do so.

The Kingdom of Saudi Arabia isn’t worried about a little thing like falling prices.

Their move to keep oil production as is — price crash or not — is about controlling market share.

Saudi Arabia’s oil minister, Ali Naimi, has said the Arab nation will tolerate prices as low as US$20 per barrel if it has too.

At the Middle East Economic Survey held in December last year, Naimi said that ‘Whether it goes down to $20, $40, $50, $60, it is irrelevant’. He later added that his country would not intervene to revive prices.

Yet, the Saudis need a high oil price to break even. The International Monetary Fund estimates the breakeven price for the kingdom is US$83.60. Over 85% of the country’s revenue comes from oil exports.

So the low oil prices should cripple the country’s economy.

In spite of this, the country is willing to take a $750 billion gamble to maintain market share. Two days ago, Forbes wrote:

The decision by Saudi Arabia, the world’s biggest oil exporter, not to cut oil production and play the role of swing producer to stabilize oil prices is also costing the oil kingdom. Saudi Arabia recently released a 2015 budget showing a $38.6 billion deficit, its largest ever, projecting a significant decrease in oil-generated revenue. But Saudi Arabia has accumulated $750 billion in foreign currency reserves and has signaled it is willing to spend its cash hoard and put it on the line in this global oil battle.

With strong currency reserves, the Saudis are telling the world they’ll win the market share game. And they’re willing to run years of deficits to maintain it.

Saudi Arabia has called 10 hearts. The question is, will the other nations play the game?

Shae Smith

PS: Jason told Diggers & Drillers readers this week that the oil price will easily slip to $42 per barrel. He also reckons a price slip into the $30 isn’t out of the question. But falling oil prices haven’t stopped Jason recommending an oil stock to Diggers & Drillers readers. Here Jason tells you why you should invest in the oil price crash.

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Since starting out in the financial markets over a decade ago, Shae has extensive experience across various aspects of the industry. Shae cut her teeth in the derivatives industry, teaching clients basic trading techniques with technical analysis.

Joining Port Phillip Publishing eight years ago, Shae has worked across a number of publications, such as Australian Small-Cap Investigator, Gold Stock Trader and Microcap Trader. She’s spent the past two years however, honing her macro analysis skills alongside Jim Rickards, showing Australians how to invest and profit form global macro trends.

Drawing on her extensive experience, Shae is a contributor to Money Morning, and lead editor of sister-publication Markets & Money, where she looks at broad macro trends developing around the world, combining them with her distaste for central banks and irrational love of all things bullion.

One response to “Saudi Arabia’s Oil Price Manipulation

  1. How can you publish this stuff? You’ve completely missed the single biggest factor, which is amazing because it’s a hard one to miss: the move is almost entirely about punishing Tehran. Duh. You might have noticed there’s a little bit of conflict going on between Iranian and Saudi proxies in Iraq at the moment? Oil prices are the big lever that SA has over cash-strapped and sanction-crippled Iran. Only a spastic could see this as a purely market driven decision with no role played by geopolitics.

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