Oil Market’s Hits 2-Year High After Saudi Arabian Arrests

For much of the recent past, oil prices have been driven primarily by supply side issues, including the ongoing tug of war between cost-saving technological advances in shale production versus concerns about supply disruptions in the more fragile oil producers (such as Iraq and Libya). In the last 10 days, however, this has given way to the influence of a hitherto unexpected, if not previously improbable political development in Saudi Arabia — the arrest of more than 200 princes, businessmen and former high-ranking officials on allegations of widespread corruption.

Where oil prices go from is suddenly a function of an inherently difficult call about politics in the Kingdom, one of the world’s largest producers and by far the most influential member of Opec. While the coming on stream of higher shale output will again be an important influence, the impact this time around is likely to pale in comparison to a new political uncertainty which, when put in a highly differentiated manner, boils down to whether recent Saudi Arabian political developments will turn out to be beneficial enablers of the larger reform drive outlined in the government’s 2030 Vision programme for economic diversification or, instead, a prelude to a higher risk of domestic political turmoil and greater regional instability.

While demand factors did have occasional influences, the main drivers of oil prices in the last few years have come from the supply side. The dramatic coming on stream of shale production did more than fundamentally change the traditional demand-supply dynamics.

It also altered the behaviour of Opec under the leadership of Saudi Arabia — first, forcing the cartel to abandon its longstanding role of “swing producer” in the hope that the resulting sharp fall in prices would substantially reduce shale output and curtail new investment into the sector; and then, when the reality of low prices proved too painful, encouraging Opec members to restore production limits under a more refined agreement that succeeded in raising and subsequently stabilising oil prices.

Then, oil markets opened for trading on November 6 to a different storyline dominated by Saudi Arabia. Prices surged in response to indications of a weekend political crackdown in Saudi Arabia. Brent rose above $64 a barrel and ended the week near a two-year high, notwithstanding general market pressures as some traders questioned the sustainability of the recent surge in financial asset prices, particularly for high-yield bonds and certain stocks.

What happens in Saudi Arabia matters a lot for the oil market and not only because of its considerable production, reserves and dominant Opec role. It also matters for the global economy more broadly.

The Kingdom is also an important player in regional politics and security, a large donor and a substantial holder of foreign assets. Recently, it has expanded its presence in global capital markets through the stepped-up issuance of bonds and preparations for the partial flotation of Saudi Aramco, expected by many to be the largest IPO in history.

Because of all this, recent Saudi Arabian developments have introduced a new uncertainty premium in the oil market. How quickly its influence on prices dissipates is a function of a lot more than the counterforce that will come from the inevitable increase in alternative production encouraged by the higher prices.

Should the recent crackdown prove an effective part of governance, accountability and transparency efforts to open the way for the faster and smoother implementation of economic reforms, it is just a matter of time before oil prices head lower gradually in the context of the longer-term economic restructuring of the Kingdom, including lower dependency on oil. Prospects would be different, however, should the crackdown turn out to be a leading indicator of political and geopolitical uncertainty, be it an internal power struggle and/or greater regional instability.

There simply is not enough information as yet to make a confident call between two such contrasting possibilities. What is clear, however, is that the oil market and energy prices have entered a new period of political uncertainty despite the near-certainty of higher shale production.

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