Global Economics and Political Environment

Assignment # 1

Muhammad Umer Farooq

08014

The Problem
The world is on the brink of the longest-lasting oil glut in at least three decades and OPECs quest for
market share makes it almost unavoidable. Oil supply has exceeded demand globally for the past five
quarters, already the most enduring glut since the 1997 Asian economic crisis. If the Organization of
Petroleum Exporting Countries (OPEC) were to keep pumping at current rates it would become the
longest surplus since at least 1985.
A little more than a year ago, Saudi Arabia, the effective leader of OPEC, the 13-country cartel that
pumps about a third of the worlds oil, decided that enough was enough. The global market was
drowning in oil, thanks to the American shale-oil miracle, and the Saudis were losing market share. They
went on the offensive.
Not even the Saudis could have foreseen the damage the decision would inflict. In the past year, Brent
crude, the global benchmark, has fallen 37 per cent to $44 (U.S.) a barrel. As late as June, 2014, Brent
was trading at $110. The International Energy Agency (IEA) estimates that the oil plunge has reduced
OPECs annual oil revenues to $550-billion from $1-trillion.

Saudi Strategy
The Saudi strategy appears to be that as a low-cost producer with massive financial reserves and almost
no debt, the kingdom can ride out an extended period of low prices better than most others in the
market. Once higher cost and financially weaker producers have been forced to cut their production,
prices will rise and Saudi Arabia will benefit from a combination of higher prices and successfully
defended market share. It is not the role of Saudi Arabia, or certain other OPEC nations, to subsidize
higher cost producer by ceding market share, Oil Minister Ali Naimi told an audience in Berlin in March.

Global Economics and Political Environment

Assignment # 1

Muhammad Umer Farooq

08014

Saudi Arabia is called upon to make swift and dramatic cuts in production. That policy was tried in the
1980s and it was not a success. We will not make the same mistake again. He said.
Saudi policymakers insist the kingdom will maintain its market share and let low prices take care of the
surplus by forcing cuts from higher cost producers and stimulating fuel demand.

The problem is that there are so far few signs of non-OPEC output actually falling and other OPEC
countries are currently trying to increase, not restrict, their output.
The impact of Riyadh playing hard ball is starting to be felt: drilling, well completions and credit lines for
US companies have taken a hit and bankruptcies loom. Although North America has taken the brunt of
the pain, it is spreading internationally.
Is the strategy working?
In my opinion, This was the only possible strategy they had. Saudi Arabia is hoping sooner or later that
the strategy will work, but they have to go through a lot of pain and it is going to be longer and costlier
than the Saudis expected. Theyre stuck in this seemingly endless trench warfare and have a bigger fight
than expected.
Saudi Arabias strategy for rebalancing the oil market through a period of lower prices shows few signs
of working so far with rival producers claiming they will raise output even as prices slide to new lows.
There are so far few signs of non-OPEC output actually falling and other OPEC countries are currently
trying to increase, not restrict, their output.
There are few signs that output growth from shale drillers and other producers outside OPEC is starting
to slow, but it is not falling yet. Within OPEC, other producers, principally Iraq and Iran, are determined
to continue raising their output even as prices slump. With prices down by more than half compared
with the same point in 2014, oil consumption is growing at some of the fastest rates for a decade.
Having adopted the strategy to strangle the U.S. shale industry by not cutting the OPEC production
output, Saudi Arabia might have misjudged the resilience of the U.S. fracking industry economy to

Global Economics and Political Environment

Assignment # 1

Muhammad Umer Farooq

08014

withstand lower oil prices. The recent Saudi Financial Stability Report published by the Saudi Arabian
Monetary Agency stated: "It is becoming apparent that non-OPEC producers are not as responsive to
low oil prices as had been thought, at least in the short-run."
However, Saudi Arabia has so-far shown itself to be resilient: retaining its share of imports to Asian
markets amid increased competition from rivals such as Iran and Iraq. Lower crude prices have also
boosted demand for refined products from the US and Europe.
A nuclear deal between Iran and six world powers raises the specter of a fresh oil glut further pressuring
prices, but any selloff depends on how successfully Tehran can increase production and sell crude in the
face of competition.
The possibility of up to a million new barrels of Iranian oil flooding global markets, the amount Iran aims
to deliver within months, comes at a critical time. Chinas stock-market turmoil in recent weeks could
slow an economy that was expected to account for a lot of energy-demand growth.
However, Saudi Arabia is only at the beginning of what could be a long-drawn out process. The effort to
rid the world of 2m barrels a day in excess supply could take several years. Even if prices bounce back to
previous highs as spending cuts reduce production too much expensive oil output could surge
again. Although Saudi officials hope flexible US shale production will prevent this, it is still uncertain.
International Oil Prices in The Medium Term (2-Years)
A nuclear deal between Iran and six world powers raises the specter of a fresh oil glut further pressuring
prices, but any selloff depends on how successfully Tehran can increase production and sell crude in the
face of competition. The possibility of up to a million new barrels of Iranian oil flooding global markets,
the amount Iranian officials aim to deliver within months, comes at a critical time. Chinas stock-market
turmoil in recent weeks could slow an economy that was expected to account for a lot of energydemand growth.
Meanwhile, U.S. production remains strong, and countries such as Iraq and Saudi Arabia are pumping
record amounts. On any given day, the world already produced more than two million barrels a day
more than there is demand for.
Once Iran is allowed to sell its oil more freely, it has some 20 million barrels in storage that it can deliver
as soon as it has buyers. After that, the country can almost immediately ramp up production by roughly
another 400,000 barrels a day from fields where the flow of oil was slowed. Following that, Iranian
engineers may be able to pump a further 500,000 barrels a day within a year or so by restarting wells
that were shut down.
However, in my opinion, most of that Iranian oil wouldnt come on to the market until mid-2016 at the
earliest, when demand probably will have picked up and supplies from countries such as Russia and USA
likely will decline. That could bode well for oil prices, which can be about $60- $70 a barrel in the
medium term (2 years).

Global Economics and Political Environment

Assignment # 1

Muhammad Umer Farooq

08014