What the Drop in Oil Prices Could Mean for Saudi Arabia

The oil industry over the years has been known for its booms and busts. Currently the world is experiencing the largest bust since 1990. Oil prices have dropped by 60%–the lowest they’ve been since 2004 (Krauss). The reasons for this are complicated, but they boil down to some simple rules of supply and demand:

Over the past few years, the United States’ production of oil has nearly doubled, causing Americans to start buying the cheaper domestic oil instead of products from foreign markets. Because of this, countries like Saudi Arabia, Nigeria and Algeria that once was sold their oil to the United States are now being forced to market themselves in Asia–and lower their prices in order to compete. Canadian and Iraqi oil production and exports are also rising continuously. Even Russia, with all its economic problems, has managed to keep the black gold flowing (Krauss).

Meanwhile, the economies of Europe and developing countries are weak, at the same time that vehicles are becoming more energy-efficient. So demand for fuel has been diminishing recently.

While this may seem great for consumers of oil (if you don’t drive, you’ve at least noticed others reacting with glee to the cheapest gas prices anyone’s seen in a decade), oil companies and the economies they’re attached to are suffering. It’s estimated that over 250,000 have already lost their jobs (Reed), with more cuts to come, even from the biggest and most secure companies. Venezuela, Iran, Nigeria, Ecuador, Brazil and Russia are just a few countries that are suffering economic and even political turbulence. The Persian Gulf states are will probably be forced to invest less money around the world, and they may cut aid to countries like Egypt. In the US, big oil states like Alaska, North Dakota, Texas, Oklahoma and Louisiana are also facing economic challenges (Krauss).

The only way to fix this, it seems, is for OPEC to intervene and cut the

oversupply of oil floating around the market. However, Saudi Arabia, which has headed the cartel on oil for years, is refusing, even with half the world pressing them to take action. Their reasoning is that if OPEC were to stop production, and the demand for oil suddenly rose, Saudi Arabia would only be helping its competitors. In fact, despite the equal toll the drop in prices is taking on their economy, the Saudi government has stated that it’s ready to allow prices to slip much lower before they do anything to stop them (Krauss). However, most oil analysts are calling their bluff.

  The thing is, Saudi Arabia needs OPEC, and this plan they’ve concocted–while serving Saudi interests–is in direct conflict with the cartel. Almost the entire Saudi government is funded off of the money they make from their OPEC oil exports (“Saudi Arabia”). And when you run a repressive authoritarian state, surrounded by unstable warring countries, with a military investment in Yemen, a newly inducted head of state and a citizenry that’s already dissatisfied with the economy, you need to make sure that everything in your regime is running smoothly. This simply cannot happen if the Saudis don’t have their oil money, or if they keep refusing to work with their partners in OPEC (Evans-Pritchard).  

Saudi Arabia also can’t expect this strategy of beating out their competitors and then selling oil at their own price to actually succeed. They would essentially be selling to a group of nations whose economies have just been gutted. In other words, most people in these countries wouldn’t be able to afford oil from OPEC at the price they plan on selling–they would already be broke!

So at the rate things are going, it doesn’t look like Saudi Arabia will be winning this fight. But what will actually happen if and when that occurs, and they have to find new strategies for making money? The surprising thing is that this “failure” could be the best thing that’s happened to the Saudi economy in a while.

For me to explain this, we have to look at the bigger picture: When a country’s main source of income stems from selling natural resources to the rest of the world, exports will be very high. As a result, foreign currency will come flooding in to pay for these exports, driving up the value of your own country’s currency. In order to avoid this huge inflation, Saudi Arabia has pegged its currency value to the US dollar, keeping their exchange rate relatively steady (Evans-Pritchard).

However, say the plan for Saudi Arabia to outlast all the other oil markets fails, and the Saudi government is forced to give up this peg; the value of their currency would then drop by 30-40% (Worstall). And that would simply do wonders for the domestic economy of Saudi Arabia. All their imports would become more expensive, indirectly causing citizens to buy domestically. This new money would make it easy to substitute OPEC oil profits with domestic production, without the added threat of inflation. In addition, anything domestically produced would then become that much cheaper on the global market. The domestic industry would be perfectly stimulated. In fact, Saudi Arabia might actually start to have a real domestic economy, instead of one based entirely on oil profits. That means they’d actually be producing things their own people want to buy–who’d a thunk it?

I know this idea is a little far reaching, especially now when the future is so uncertain. Still, it is interesting to think about as the situation evolves. Until then, the oil industry can keep us engaged with its continued cycle of booms and busts.

Evans-Pritchard, Ambrose. “Saudi Arabia Risks Destroying OPEC and Feeding the ISIL Monster.” The Telegraph. Telegraph Media Group Limited, 11 Nov. 2015. Web. 18 Jan. 2016.

Evans-Pritchard, Ambrose. “Speculators Test Saudi Currency as Oil Crisis Deepens.” The Telegraph. Telegraph Media Group Limited, 20 Nov. 2015. Web. 18 Jan. 2016.

Krauss, Clifford. “Oil Prices: What’s Behind the Drop? Simple Economics.” The New York Times. The New York Times Company, 15 Jan. 2016. Web. 18 Jan. 2016.

Reed, Stanley. “Stung Low by Oil Prices, BP Will Cut 4,000 Jobs.” The New York Times. The New York Times Company, 12 Jan. 2016. Web. 18 Jan. 2016.

“Saudi Arabia.” 2015 Index of Economic Freedom. The Heritage Foundation, 2015. Web. 18 Jan. 2016.

Worstall, Tim. “The Oil Price Crash Could Be the Best Thing that Happens to the Saudi Arabian Economy.” Forbes / Economics and Finance. ForbesBrandVoice, 21 Nov. 2015. Web. 18 Jan. 2016.

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