December 9, 2015 / 12:53 PM / 4 years ago

Yamani legacy haunts the oil market: Kemp

LONDON (Reuters) - “All political lives, unless they are cut off in midstream at a happy juncture, end in failure, because that is the nature of politics and of human affairs,” wrote British politician Enoch Powell.

Saudi Arabia's Oil Minister Ali al-Naimi attends a meeting at the U.S. Center during the World Climate Change Conference 2015 (COP21) at Le Bourget, near Paris, France, December 8, 2015. REUTERS/Jacky Naegelen

Saudi Arabia’s veteran Oil Minister Ali al-Naimi may wonder if he is destined to become the scapegoat for the current collapse in oil prices which is inflicting so much damage on the kingdom’s finances and economy.

Ahmed Zaki Yamani, Naimi’s predecessor-but-one, was dismissed by King Fahd in 1986 following a prolonged slump in prices. Naimi could be forgiven for wondering if history will repeat itself.

Saudi Arabia has had just four oil ministers in the last 55 years: Abdullah Tariki (1960-1962), Yamani (1962-1986), Hisham Nazer (1986-1995) and Naimi (1995 - ).

The petroleum minister has always been the most powerful member of the government from outside the royal family.

But like all ministers, the oil minister serves at the pleasure of the king and the court, and if policy is deemed to have failed the minister is ultimately responsible.

TIMING IS EVERYTHING

Naimi was reportedly asked to nominate possible successors in 2010. But the expected cabinet reshuffle was postponed as the kingdom’s rulers sought to project an image of stability and continuity amid the revolutions convulsing the Arab world in 2011.

If Naimi had been allowed to retire as planned in 2011 he would have left office a hero for orchestrating production cuts among the members of the Organization of the Petroleum Exporting Countries (OPEC) in 2008/09 and engineering a recovery in prices following the global financial crisis.

For three and half years between 2011 and mid-2014 oil prices averaged over $100 and cash poured into the kingdom, enabling it to build up financial reserves of more than $730 billion.

Then it all went wrong.

Brent oil prices slumped from around $115 per barrel in June 2014 to $77 by November in response to slowing demand growth and accelerating supply, especially from U.S. shale.

Guided by Naimi, OPEC decided in November 2014 to maintain its production, defend its market share, and let prices fall to curb the growth in production from high-cost rivals.

Prices have slumped further. One year later, prices have fallen by another $37 to $40 per barrel.

OPEC members are hemorrhaging cash. Even Saudi Arabia’s formidable reserves are draining away rapidly.

Commentators with close links to the Saudi oil ministry insist the kingdom’s policymakers always understood it would take 2-3 years to curb shale growth, encourage more demand, and rebalance the oil market.

But almost 18 months into the price slump, progress has toward rebalancing has been far slower than anyone, including the Saudis, thought likely in 2014.

SLOW STRATEGY RESULTS

U.S. shale production has stopped accelerating but remains stubbornly high. Russia has increased its output. Most other oil producers have also increased production in part to offset lower prices.

Oil demand has increased by 1.8 million barrels per day in 2015. But the market remains oversupplied. Stocks are rising by more than 1 million barrels per day.

Iran, whose oil exports have been crippled since 2012 by sanctions related to its nuclear program, is poised to increase its production and exports if sanctions are lifted in 2016, adding to the oversupply.

Saudi officials insist they will not cut production unless other non-OPEC countries agree to reduce their own output and Iran and Iraq accept limits on future production growth.

The result is that the latest OPEC meeting ended on Dec. 4 without any agreement at all on production, leaving members free to pump as much as possible in the months ahead.

Brent prices have continued to slide and are now at the lowest level since the depths of the slump in February and March 2009 that followed the global financial crisis.

Historians will argue for years how much the crisis reflects forces beyond Saudi Arabia’s control and if it has been worsened by miscalculations in Riyadh.

Saudi Arabia was clearly correct to recognize a price above $100 had become unsustainable by mid-2014 because it was encouraging too much supply and not enough demand. Much lower prices were required to rebalance the market.

But whether it was right to unleash a volume war for market share and flood the market with excess crude oil is more controversial.

It is not clear what alternative course Naimi could have taken in 2014, but if he hoped to curb production from high-cost rivals in the U.S. shale fields, the North Sea, Russia, the Gulf of Mexico and other areas, the results have been meager so far.

The strategy has led to a complete collapse of cooperation within OPEC itself, which is no longer even making a pretence of acting like a cartel.

Saudi Arabia launched a volume war on other oil producers in 2015; Iran is poised to respond in kind in 2016.

Volume warfare has shifted the battle from between OPEC and non-OPEC to inside the cartel itself.

Saudi Arabia is now at loggerheads with almost everyone in the oil market - from Russia, U.S. shale producers, Iran, Iraq, Venezuela, Ecuador and Nigeria to the oil majors. Just about the only allies the Saudis have left are Kuwait and the United Arab Emirates.

The slump may have begun with factors outside Saudi control, but the kingdom’s policy has arguably made it worse and left Riyadh isolated, with few friends and no good options. The question is whether a more nuanced and emollient policy could have rendered the slump shorter and less deep.

REPRISE OF 1986?

Volume warfare looks and sounds a lot like the situation in the mid-1980s when Saudi Arabia tired of acting as the swing producer and ramped up its production to win back market share lost to rivals within OPEC as well as producers in the North Sea, the Soviet Union and the Gulf of Mexico.

In 1986, unrestricted volume warfare sent oil prices plunging to an average of $14 per barrel, around $31 today after adjusting for inflation. At one point, prices dropped below $10, around $22 today after adjusting for inflation.

Current news reports about the disarray within OPEC bear an eerie similarity to press reports from 1986 cited by economist Morris Adelman in his retrospective study on OPEC in the 1980s (“The Cartel in Retreat” 1993).

“Saudi Arabia believes that the price war eventually will eliminate much oil from non-OPEC producers, such as Britain and the United States, because their oil is too expensive to produce,” the Wall Street Journal reported on June 30, 1986.

“The Persian Gulf producers said prices had fallen to ‘unacceptable levels and only cooperation between all producers inside and outside OPEC’ could improve matters,” according to the New York Times in March 1986.

“Even the Saudis are becoming concerned about the rapidity and depth of the current price plunge,” Petroleum Intelligence Week wrote, also in March 1986.

Ultimately, volume warfare failed to produce the hoped-for reduction in non-OPEC supplies, at least not until many years later.

OPEC called a ceasefire in the second half of 1986 and the Saudi oil minister, Yamani, was dismissed by the end of October.

Yamani was removed for a variety of reasons, not least because he had become estranged from then-king Fahd and other powerful princes, and was seen as an overmighty subject, according to his biographer (“Yamani: the Inside Story” 1988).

But there is no question that he was also a scapegoat for a failed oil policy and his removal signaled a change in direction imposed from within the royal court.

There are important differences between 1986 and 2015 so the parallel should not be taken too far.

Saudi Arabia had been cutting rather than raising production in the early 1980s. The kingdom’s foreign reserves are in much better shape currently to withstand a prolonged financial siege.

Yamani shouldered the blame for the failed experiment with netback pricing. And shale production may be more responsive to low prices than the North Sea was in the 1980s.

But Saudi Arabia is once again embroiled in a price crisis, the biggest since 1986. The current minister must hope this time it ends differently.

(The opinions expressed here are those of the author, a columnist for Reuters.)

Editing by William Hardy

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