Change and tension

May 8, 2017
Because Saudi Arabia makes or breaks the latest rendition of oil-supply management, developments there strongly affect the future price of crude. What safely can be said about developments in the kingdom is that they are changing.

Because Saudi Arabia makes or breaks the latest rendition of oil-supply management, developments there strongly affect the future price of crude. What safely can be said about developments in the kingdom is that they are changing.

As Saudi commitment to production restraint goes, so goes compliance with agreements to limit output by all but two members of the Organization of Petroleum Exporting Countries and by 11 nonmembers. If Saudi Arabia breaks rank, others will follow. Halfway through the 6-month production accord in effect since Jan. 1, Saudi resolve was clear. The International Energy Agency estimated the kingdom's compliance level through March at 132%.

Two contexts

Questions about durability of that commitment must be addressed in two contexts. One of them is the level of compliance by other participants in the production agreement. Saudi officials spooked the oil market in March with a reminder that they don't intend to defend the crude price solo. In its April Oil Market Report, IEA estimated OPEC's compliance during the first 3 months of the production accord at 99%. Non-OPEC collaborators have been slower trimming output. IEA estimated their compliance March compliance level at 64%. But that was up from 38% in February.

The other important context for assessing durability of the production accord is churning in the House of Saud. When the government a year ago announced an ambitious program of economic modernization called Vision 2030, the reported illness of King Salman already made succession a topic of growing concern. Deputy Crown Prince Muhammad bin Salman, defense minister and chairman of the Council of Economic Development, designed Vision 2030 and heralded it as way to move the Saudi economy away from dependence on sales of crude oil. But the plan has tepid support from Muhammad bin Salman's older cousin, Crown Prince Muhammad bin Nayef. It is far from certain that Bin Salman would supersede Bin Nayef on the king's death, the monarch's apparent wish, and whether Bin Nayef, if he becomes king, would designate his younger rival crown prince.

These intrigues hold implications for oil prices in part because of a crucial piece of Vision 2030: the sale of a small part of Saudi Aramco. The initial public offering, planned for next year, gives Saudi Arabia powerful incentive to defend the price of crude. The government needs the proceeds to balance accounts and fund Vision 2030 investments. But the IPO take, according to numerous reports, might fall well short of the promoted $2 trillion.

Pessimism about IPO results might strengthen Saudi determination to support the crude price. But it also might strengthen factions of the royal family distressed by production strategy oriented to price at the expense of market share. Bin Nayef is said to belong to that camp.

Bin Salman faces inevitable resistance from conservative relatives to cultural changes embedded in Vision 2030. And his popularity suffers from the military quagmire developing in Yemen. In what looked like a rebuke to Vision 2030 and its champion last month, the government reversed cuts made in September to civil service salaries and benefits-most of the nonroyal payroll. Although the fiscal damage further increases pressure on the government to support crude prices, any retreat from the reform program hints at wavering support for Bin Salman and the possibility of a swing back to market share as the priority of production decisions. While reinstating public-worker benefits, though, the king also announced cabinet appointments that broaden the deputy crown prince's power base.

The extension

Despite these conflicting signals, Saudi Arabia is widely expected to support a 6-month extension of production limits when OPEC meets to address the question on May 25-if non-OPEC commitment remains in place. The overarching reason is the government's aversion to public unrest, which flares when the oil price slumps. If the kingdom supports extension, others will, too. And in an anxious market, tension will ease.