OPEC will have its incoming meeting Nov. 27. This is a considerably important meeting for oil prices, global economic growth and all motorists in the world. OPEC has said that it will not cut its production and will let oil prices, which have already plunged by more than 25 percent this year, decline.
Will OPEC cut its production in order to stabilize oil prices? In other words, are the Saudis bluffing about being comfortable with current oil production and are they actually not happy with the market doing the pricing?
To answer this question, we can look at OPEC’s current production and its production history. And since OPEC is really Saudi Arabia, we can bring up the subject of whether the Saudis are tactical or strategic decision makers.
OPEC’s current production for this month has dropped by 220,000 barrels a day. While this is a symbolic cut because OPEC needs to cut production between one to one-and-a-half million barrels a day out of it current production of more than 30 million barrels a day to stabilize prices, it goes against what it has been saying that it will not cut production in its scheduled meeting.
It will be interesting to know who has been doing the current cut. Specifically, it will be very interesting to discern if Saudi Arabia is doing the cut.
Historically and sporadically, OPEC and Saudi Arabia followed policies that let the market determine oil prices. In 1985, the Saudis moved from being the first-mover swing producer that cut production to prop up oil prices to letting the market do it through introducing the net back pricing formula.
Shortly, oil prices collapsed from $40 a barrel to $10. The Saudis realized that the oil market had unusual dynamics and the market cannot be trusted in determining the oil price. In 1999, OPEC did not cut production in the wake of the 1997 Asian financial crisis and then oil prices also collapsed to $10 a barrel.
OPEC retreated and cut production in 2000 through introducing the target zone pricing. The OPEC oil price then jumped to $25 a barrel. Therefore, it will be interesting to develop an economic theory on the dynamics of the oil downward spiral. It seems that oil prices can drastically drop within a short period of time if the circumstances are not favorable.
Applying this narrative to the current circumstance, oil prices can plunge to $50 a barrel if OPEC does not act, a price that can harm almost all OPEC members — including Saudi Arabia, which has an inflated government budget to chase the Arab Spring away from its borders.
Recent history tells us that the oil price has a floor of $30 a barrel. This price floor prevailed during the horrible period of the Great Recession. But the world is not in a global recession; thus, $50 may be the worst case scenario for the current period if OPEC does not act.
Reading the oil and political policies of Saudi Arabia, one can infer that its decision makers are more tactical than strategic. This means they are more interested in the short-run than the long- run.
Their tactical policy can be detected from their strategies in Yemen and Egypt a well as from their oil decision-making. It can also be inferred from their policy with the Islamic State group and the domestic war in Syria. This is not surprising because the country is highly oil-based and does not have an elected government.
Back to OPEC, the member states will have a difficult meeting and will stack up Iran and Venezuela against Saudi Arabia and its allies. If there is no agreement and the oil price collapses below $70 a barrel, it will increase the tension in the Middle East particularly between Iran and Saudi Arabia and will also increase the worries of Saudi Arabia about meeting its fiscal obligations despite its $450 billion in international reserves.
Based on that and the record of Saudi decision-making, OPEC is likely to converge into cutting oil production between 500,000 to one million barrels a day. The oil markets has somehow sensed that and increased prices Nov. 14. Tactics overwhelm strategies for Saudi Arabia.
Shawkat Hammoudeh is an economics professor at Drexel University. He can be contacted at [email protected].