Oil prices unlikely to rise sustainably

Oil-producing countries like Saudi Arabia and Russia are highly dependent on the level of the global oil price. The oil price has fallen dramatically over the course of the last two years, mostly due to an oversupply of shale oil by the USA and the increase of Iranian oil production, as well as the “flooding” of the market by OPEC. The cartel’s strategy was to undermine oil production in these countries in making it unprofitable to produce at the given price – and this strategy apparently has failed. The oil price has only recently risen from an extremely low level of $28.94 in January to $56.82 in December 2016. Furthermore, OPEC and Russia are planning for new measures to raise the oil price. In December, OPEC decided to cut oil production in order to relieve the economic pressure lasting on several oil-producing states.

Data as indicated by Bloomberg Markets

Currently, this measure appears to be successful. The oil price is slowly rising and hovering around $58 per barrel. Additionally, the quantity of oil output could be reduced to 50% according to an estimation by Bloomberg. This whole strategy is resting on the assumption that the cartel members will stick to their agreement but this is unlikely. OPEC already has had difficulties to live up to its agreements on oil output in the past due to its nature as a cartel. There is an incentive for cartel members to cheat and to abandon the common strategy: If oil prices would rise, everyone would have an incentive to sell more of their oil in order to achieve a higher price. The longer the members would stick to the strategy, the higher the price would go and therefore the incentive to cheat would become increasingly tempting.

Political consequences

This means OPEC’s capacity to control the output quantity and therefore influence the price is limited. As a consequence, the oil price is likely to raise in the short term but will most probably return to a low level, thereby provoking states suffering from the low oil price to seek alternative solutions to their problem. This particularly concerns Russia and Saudi Arabia, both being highly dependent on their oil exports. The Russian and the Saudi economies have significantly suffered from the low oil price, it is therefore necessary to assume that these two states will try to reduce the quantity of oil on the global market. Reducing their own output is only one of the possible strategies.

Russia suffers from the sanctions of the European Union and the United States but it suffers even more from the low oil price. The Russian economy needs to grow despite the fact that President Putin’s popularity and approval ratings are still high. Depending on how long the EU sanctions and the Russian involvement in the Syrian Civil War will last, Moscow needs more financial resources in order to maintain its ability to act, to have room for manoeuvre. Saudi Arabia, on the other hand, does not suffer from sanctions of any kind but needs financial resources in order to maintain its political and military activities. Riyad currently is involved in a “Cold War” with Iran over the wars in Syria and Yemen and therefore cannot afford to get weakened.

Therefore, Saudi Arabia’s strategy in foreign policy hugely depends on oil revenue. Another example for this is the Saudi strategy during the Arab Spring where Riyad did not only support the Bahraini regime in sending troops against the protesters but also introduced social welfare measures in the kingdom itself in order to prevent demonstrations. Such a strategy is only functional if the Saudis dispose of sufficient financial resources. Budgetary restraints and difficulties arising from the throne succession could very well lead to a difficult and uncomfortable situation for the kingdom’s political elite in the future, most likely worsened by a lower-than-possible oil price.

It is ironic that Russia and Saudi Arabia are working together in their efforts of raising the oil price, given their divergent interests in Syria. Saudi Arabia supports the opposition while Russia aligned itself with the regime of Bashar al-Assad, a close ally of Iran and therefore an adversary of Saudi Arabia. Both countries realised that they are highly dependent on the oil price level and therefore bound to cooperate in this matter. If the oil price does not recover because of an OPEC member cheating, a scenario described above, both have to find alternative ways of restricting the oil output. Saudi Arabia most likely will aim on undermining the slow process of rapprochement between the international community and Iran. Russia, on the other hand, may be tempted to provoke other conflicts in the Middle East in order to stop the oil extraction.

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