When Saudi Arabia last month announced with Russia and other big oil producers a conditional agreement to freeze production at current levels in the face of rock bottom prices, the decision was seen as an indication that it was changing policy. Economics had finally trumped geopolitics. Where Riyadh’s earlier decision not to cut output was seemingly spurred by geopolitical rivalry with Iran and Russia, economic hardship had catalysed co-operation.
It is correct to focus on both economics and geopolitics in assessing Saudi behaviour. There is just one problem: most people get it back to front, concluding that geopolitics are the dominant driver when economics are, and vice versa.
In 2014 Saudi Arabia convinced other Opec members to abandon efforts to support prices by cutting output and to prioritise instead the protection of market share. This precipitated the dramatic price collapse of the past few months. Given Russian and Iranian support for, and Saudi opposition to, Syrian President Bashar al-Assad — and the growing possibility of a nuclear deal leading to the lifting of sanctions against Iran — analysts were inclined to see the Saudi-led decision as geopolitically inspired. The new approach unquestionably created more hardship for the kingdom’s nemeses: Iran and Russia.
But the fact that something desirable results from an action does not necessarily mean it was the cause of it. In fact, the Saudis had little choice but to opt for a market share approach in 2014. Like others, they misjudged the depth of the price collapse to come. Yet they understood that US shale oil had created new dynamics that limited their choices.
The Saudis faced competition from a sector whose output could be adjusted more swiftly in response to price fluctuations. They suspected that if they cut their own production to bolster price, the shale industry would respond by producing more, eroding any increased Saudi revenues by pulling the price back down. The Saudis would then be selling less oil and at a lower price. Here, prioritising market share over price made the most economic sense. The problems created for Tehran and Moscow were icing, but not the cake itself.
In contrast, the tentative agreement this year to freeze oil production was almost all about geopolitics, not economics. The clue is in the fine print, which says the freeze would take effect only if other producers, primarily Iraq and Iran, agreed to halt their own production increases. The really tall order was to convince Iran, newly freed from sanctions, to agree to this deal. Not surprisingly, Iran balked.
Although to many the initiative looked like a flop, the kingdom achieved its goals, which were geopolitical not economic in nature. Riyadh had the satisfaction of lining up two of Tehran’s closest allies — Russia and Venezuela — in opposition to Iran’s position. More important, in making the proposal while holding out little hope that Iran would agree, the Saudis shifted the blame for low oil prices. Tehran became the new bad boy of the oil market.
Both economics and geopolitics will shape Saudi oil policy in the days and months ahead. Geopolitics will be the main driver for actions that have an economic upside only. But where economics and geopolitics point in different directions, expect Riyadh to prioritise the first. Faced with a gathering economic crisis, Saudi Arabia cannot afford expensive pot shots, even at regimes for which it has no love. Its strategy of prioritising market share will probably persist for a while.
But, once the market starts to turn, and Iraq and Iran have shown their ability to bring new oil to market, production cuts could yet return.
The writer is a professor and the director of the geopolitics of energy project at Harvard University’s Kennedy School
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