Al-Sayari faced tough choices. As central bank governor, he oversaw the rapid drawdown of fiscal reserves while budget deficits rose. Revenues had plunged, and the government, desperate for income, was forced to rein in expenditures, mostly by suspending construction projects, delaying payments to contractors and suppliers, and even cutting back on military spending. Faced with declining prices and cheating OPEC partners, in December 1985 Saudi Arabia abandoned its restraint and decided to unleash its own production. Prices, which had tumbled by a quarter, sank by another half in the next year alone.
The boom of the 1970s and early 1980s was now a bust. The recession and the Saudi government’s response undermined business confidence, deterred private sector investment, and spurred extensive bankruptcies in the country. Perhaps most alarmingly, it stoked discontent among the Saudi population. In late 1984, the government raised heavily subsidized electricity prices, but was forced to backtrack a year later with the aim of “relieving the financial burden of the people.” In early 1986, the Economist noted:
What should really worry the ruling families is that all over the Gulf people are beginning to complain about the amount of money the rulers are making while everyone [else] is getting worse off. In the good times, no one minded that the rulers took slices of the biggest contracts, or kept the most profitable businesses for themselves. But when the whole cake shrinks, and the amount of it which the rulers are getting stays the same or even increases, people begin to notice. Some of the rulers are being accused of helping to put merchants out of business—behavior that does not endear them to the rest of the trading community.
Figure 1.5: Saudi Arabian Oil Production, Consumption, and Net Exports, 1971–1986 (million barrels per day)
As reported by BP World Statistical Review 2016; 1965–1983 prices are Arabian Light prices posted at Ras Tanura; 1984–1986 are Brent prices.
Source: IEA: World Oil Statistics, 2016; BP, BP Statistical Review of World Energy 2016—data workbook, 2016.
More than two decades later, these negative memories of the 1980s would form the critical backdrop against which Saudi leaders and officials would respond to the 2014 price plunge. As 2014 began, oil prices were still around $100 a barrel and most Saudi leaders didn’t regard surging U.S. tight oil production as a challenge to the comfortable status quo. After meeting with U.S. energy secretary Ernie Moniz in January 2014, then Saudi Arabia’s much revered minister of petroleum and mineral resources Ali al-Naimi exuded calm, saying, “The Kingdom welcomes this new source of energy supplies that contribute to meeting rising global energy demand and also contribute to the stability of the oil markets.” Certainly, many big oil producers had grown accustomed to high oil prices. Fiscal breakeven prices—the minimum oil prices producers need for their budgets to be in balance—had doubled or more in a few short years, reaching or exceeding the $100 mark. For many Middle Eastern monarchies, high oil prices were a blessing given the volatile politics of the region and the need, in some cases, to buy political quiet within their own borders. Al-Naimi publicly interpreted the price stability as an indication that both consumers and producers were comfortable at this price level, suggesting that it could continue indefinitely.
Figure 1.6: Nominal and Real Oil Prices Real Prices as of December 2014
EIA, Short-Term Energy Outlook Real and Nominal Prices, December 2014.
While global demand for oil was steady if flat in 2014 before the price began to drop, it was initially weakening demand for the kingdom’s own crude throughout the summer of that year that made Saudi officials nervous. As American tight oil production boomed, the United States was importing less and less oil, not just from Saudi Arabia, but also from Venezuela and West African producers, which were also traditional suppliers of U.S. markets. These countries aggressively began to seek other markets for their exports, for example, pushing to secure Chinese customers at the expense of Saudi exports. In the eighteen months following January 2013, Chinese imports of Saudi crude fell by more than a third. As a result, even before global prices faltered, Saudi Arabia was giving discounts to many customers in an effort to win back and hold its market share.
As the global price dipped below $100 in the autumn of 2014, the road ahead looked fairly straightforward to many. The common wisdom was that Saudi Arabia—not to mention other members of OPEC—could not afford to let prices sink too low in the face of bloated budgets and potentially restive populations, especially as the Arab revolutions swept the region. The world expected OPEC, or at least Saudi Arabia, to rein in its oil production as prices began to soften. Global supply and demand would subsequently settle at a price that would—not coincidentally—be close to that needed by OPEC leaders to balance their fiscal budgets, about $100 a barrel in late 2014.
Such a turn of events would have been consistent with what had become a familiar OPEC playbook. Following the 1973 embargo, the Arab countries of OPEC absorbed some tough lessons. That oil embargo, which caused prices to soar, had been catastrophic—not just for oil consumers but for producers as well. The hardship Al-Sayari described to me extended well beyond Saudi Arabia. Not only did the global stagflation resulting from the high prices of the 1970s curb oil demand, but investment into oil-producing economies, on the whole, fared more poorly than other developing countries. The message to members of OPEC was clear: oil embargoes cause economic pain for everyone.
Subsequently, OPEC shifted its approach to more nuanced interventions in the oil markets. Its efforts were generally limited to calibrating its oil production to support prices within a range that its members thought was fair and sustainable. Often, this meant restricting supply and keeping prices higher than they would have been if the market were the only arbiter of price. For instance, OPEC cut millions of barrels of production after oil prices plummeted in the wake of the 2008 financial crisis, quickly boosting the price. On more rare, although significant, occasions, OPEC had also brought additional supply online, dipping into its “spare capacity”—that is, oil from developed fields and infrastructure that some OPEC countries keep offline, but have the ability to bring to market in thirty to ninety days. For example, in 2011, OPEC used its spare capacity to keep prices from spiking when international military action in Libya curtailed global supply on short notice. While OPEC’s post-1973 approach did not eliminate volatility in the oil market, its actions often helped shave the peaks and troughs off the changes in the price of oil. Had OPEC not played this familiar role, the only mechanism to bring supply and demand into balance would have been price; given the sluggish response of oil supplies to price, the adjustments would have been longer and more disruptive.
Most analysts had not had the benefit of the conversation I had at the Saudi Ministry earlier that year. As a result, and given OPEC’s history, the debate among oil market observers in 2014 was initially more about when OPEC, and Saudi Arabia in particular, would step in and cut production to shore up price. Few people were asking if OPEC would assume its traditional role of bolstering prices when they flagged. Yet, as described to me by many Saudis, Saudi officials were determined not to repeat the mistakes of the 1980s. The main architect of the Saudi—and therefore OPEC—response was Ali al-Naimi. Widely referred to as “the world’s most powerful oilman” or “the closest thing the oil industry has to a celebrity,” al-Naimi had seen it all. Born in 1935 to one of Saudi Arabia’s last nomadic tribes, al-Naimi spent his early years tending lambs outside the family’s tent. He joined Aramco—Saudi Arabia’s national oil company—at the age of eleven, working his way up the company over the next thirty years until he was named president in 1984, soon after Minister Zaki Yamani had ratcheted back the country’s oil production in response to burgeoning North Sea and Alaskan oil supplies and shortly before the massive price plunge of 1985–1986. Al-Naimi must have tried to distill lessons from this period, when the Saudis lost market share and then revenues as the oil price collapsed. In 2014, when once again faced with a surge in non-OPEC supply, one can see why al-Na
imi called into question whether cutting production was the right course of action.
The United States was not the only country putting more oil on the market in the early 2010s. Other non-OPEC producers had also been enticed to increase production by the comparably high prices of the preceding years. Since 2004, Brazil had increased its production by half. Colombia nearly doubled its production, hitting the 1 mnb/d mark for the first time in 2013. Canada’s crude production was up by nearly a third. And Russia was producing at a post-Soviet all-time high—indeed, at or above the levels of Saudi Arabia throughout the first half of the decade. Collectively, non-OPEC producers apart from the United States added nearly another 5 mnb/d between 2000 and 2014.
However, it was the American tight oil production that was most problematic from al-Naimi’s and OPEC’s perspective. It was not simply the large volume of tight oil that had come to market. The resource’s unusual production characteristics were much more troubling. Up until the entry of millions of barrels of tight oil onto the market, OPEC had a pretty clear picture about what it could expect when it cut production in order to elicit higher global prices for oil. As happened repeatedly over the previous decades, higher prices stimulated new investment and eventually new production, particularly from non-OPEC countries where oil production tended to be more costly.
But this added conventional production was slow to come online, especially as companies needed to go farther and farther afield to look beyond “easy oil” for new resources to tap. The time that elapsed from when high prices spurred the initial investment to first production took years, and the cost often reached billions of dollars. For example, Kazakhstan’s Kashagan oil field—sarcastically known to industry insiders as “Cash All Gone”—took thirteen years from discovery to first commercial production, before going offline again for several years. By some estimates, the field required $116 billion to bring online. Less complicated fields still required many years to go from exploration to production. But once these investments were made and oil was flowing, the additional costs to maintain oil production were minimal in comparison. Economists called conventional oil supply “inelastic,” meaning it was only very slowly responsive to price. As a result, up until the tight oil phenomenon, OPEC could be confident that if its suppliers cut production, they could enjoy the higher prices and resulting revenues for a long period before new supplies would enter the market and place downward pressure on price.
America’s new tight oil was a different animal. Unlike the conventional oil fields that had met the world’s needs in the past, tight oil did not entail massive projects or expensive wells with tens or even hundreds of millions in front-loaded costs. Extracting tight oil, in contrast, involved quickly drilling hundreds or thousands of wells into shale rock that were downright cheap—at least up front—compared to their conventional counterparts. The average cost to drill and complete an onshore well in one of the five large American tight oil basins in 2016 was approximately $5 million; it might have been twice that five years earlier. Either way, this sum is seen as paltry when compared to more than $200 or $300 million to drill and complete a deepwater well in the Gulf of Mexico.
Such tight oil investments could also be made incrementally, not only when a company was ready to commit hundreds of millions or more dollars to a project. Ultimately, tight oil costs per barrel were more than conventional ones; because production of a shale gas or tight oil well declined very rapidly after an initial burst, continued production of these unconventional resources required constant investment to maintain a steady or rising level of output. But, tight oil wells took only weeks or months to drill, rather than years, before oil would gush forth and be sped to market. A higher global price of oil would simply—and quickly—encourage more developers onto the plains of North Dakota, Texas, and other states with tight-oil-producing basins. The higher the price, the more fields became commercially viable, even beyond the “sweet spots” sung about by the industry.
For al-Naimi, the implications of this new resource for OPEC seemed ominous. From decades of experience, he knew that if the cartel curtailed production and forced up global prices, others would take it as an invitation to eventually bring even more expensive oil online. But with the new tight oil delivering additional production so quickly, Saudi Arabia and others would have far less time than in the past—perhaps only months—to benefit from higher prices before new supply encroached. Saudi Arabia could end up with a smaller share of the market with prices only marginally higher, if at all. It would, in short, be like the 1980s all over again.
The opposite outcome, however, seemed at least equally plausible. With lower prices, America’s tight oil producers might curtail investments quickly. The production growth of the previous years would quickly grind to a halt and reverse, bringing price stability at some lower notional price at which it would not make sense to produce more tight oil.
The responsive, flexible, and plentiful nature of American tight oil had changed the game Saudi Arabia and OPEC could play. Al-Naimi was also skeptical that OPEC countries could agree on and adhere to a program of production cuts. OPEC agreements had always been undermined by a certain amount of cheating; compliance with the 2008 agreement was about 70%, which was good by OPEC standards. But in 2014, political divisions were so high that even reaching an agreement to cut production was going to prove difficult. Both Iraq and Iran argued their historical circumstances warranted that they receive special treatment. Members from Venezuela to Nigeria cautioned that their budgets were already so curtailed that any cut to their own production would create real risks to regime stability. Even Kuwait and the United Arab Emirates (UAE), the countries Saudi Arabia could traditionally count on to join in production cuts, felt more financially vulnerable given the political instability in the region and the need to keep social spending high. Nor could Saudi Arabia rely on non-OPEC producers, such as Russia and Mexico, to join it in a production cut as they had in the past. In November 2014, Venezuela’s representative to OPEC, Rafael Ramírez, organized a meeting between al-Naimi and senior energy officials from Russia and Mexico at the upscale Vienna Hyatt. The meeting, designed to explore joint production cuts, ended with no deal. At the time, no country was willing to cut production with revenues already on the decline and so little trust among producers.
These circumstances led al-Naimi to make the case to others in the Saudi government that the right response to the drop in prices was to do nothing. Domestic politics likely strengthened his arguments. Saudi Arabia’s King Salman bin Abdulaziz Al Saud had inherited the throne less than a year earlier, and the region was in unprecedented turmoil. Riyadh could little afford an oil strategy that made the kingdom look weak. An effort in which Saudi Arabia assumed its traditional role and cut production, but made no impact on price, would seem to communicate that Riyadh had lost its unique ability to shape the global market for the world’s most strategic of commodities.
There were, of course, some significant uncertainties in al-Naimi’s calculus. Producers with higher costs, such as those working in Brazilian deepwater fields and Canadian oil sands, would halt new investments when confronted with lower prices. However, as in the past, it would likely take years before these moves would be reflected in the global supply balance. But tight oil was a new and untested phenomenon. Although its responsiveness to price was unquestionably quicker than conventional resources, no one knew exactly how fast a price drop would translate into shuttered rigs and decreased production. Moreover, no one knew exactly at what price America’s tight oil producers would pack it in.
The Saudis apparently had spent much of the previous year seeking the advice of analysts from ExxonMobil and elsewhere to help them understand more about U.S. tight oil. Jamie Webster, an oil market analyst who met with Saudi officials dozens of times to discuss the new dynamics, exclaimed to me: “You could make a whole career just briefing the Saudis about new American production.” They were eager to comprehend how tight oil producers were financed
and what the projections were for future production. But most importantly, the Saudis sought solid answers to the question “What is the breakeven cost for U.S. tight oil producers?” No one inside or outside the desert kingdom knew the answer. But by the time I visited in September 2014, I sensed a consensus had settled at around $80. That same month, Ibrahim al-Muhanna, one of al-Naimi’s top advisors, told an audience in Bahrain that he did not expect prices to drop significantly below $90 a barrel, given the high cost of producing U.S. tight oil. Later reports of stress tests done of the Saudi 2015 government budget at an oil price of $80 seemed to suggest similar expectations. After years of high oil prices, the finances of Saudi Arabia were flush. The country had virtually no government debt and boasted more than $700 billion of financial reserves. While others might feel the strain, Riyadh was confident it could endure oil prices of $70 or $80 if that is what it took to force higher-cost producers out of the market and bring back market stability.
Such is the backdrop to the November 2014 OPEC meeting. Pundits excitedly claimed that this meeting would be one of the most significant in OPEC’s history. Headlines such as “Cancel Thanksgiving: The Most Important OPEC Meeting in Years Is Happening on Thursday” were commonplace online and in print media. Hundreds of journalists put on their winter garb, traveled to the organization’s headquarters in Vienna, Austria, and waited for hours as OPEC’s then–twelve members debated the situation and the correct course of action. Finally, al-Naimi, the most watched man of the event, emerged from the meeting smiling and announced to the press that the group had made “a great decision”—one that, in effect, changed nothing at all.
Although there had been pleas from OPEC’s poorer members for a production cut, the view of Saudi Arabia had prevailed. OPEC issued a statement making clear no production cuts would follow. Members had agreed to maintain the current production ceiling of 30 mnb/d, despite the organization’s own estimate that this amount would exceed the demand for its oil by more than one million barrels in the first half of the coming year. The meeting adjourned, and representatives of the cartel’s members fanned out to speak to the press. Those who spoke on the record emphasized a common message of OPEC unity; many speaking on a not-for-attribution basis grumbled about having no choice given the Saudi stance.
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