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THE DOMINANT ROLE OF THE DOMINANT ROLE OF SAUDI ARABIA IN THE SAUDI ARABIA IN THE

OIL MARKET 1997-2010OIL MARKET 1997-2010Nourah AlYousefNourah AlYousef

Associate Professor of EconomicsAssociate Professor of Economics..

King Saud UniversityKing Saud University..

alyousefn@yahoo.comalyousefn@yahoo.com

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Saudi Arabia and the oil Saudi Arabia and the oil marketmarket

Saudi Arabia played an effective part for Saudi Arabia played an effective part for the period 1974-1985, where it had the the period 1974-1985, where it had the title role in the Swing Producer Model. In title role in the Swing Producer Model. In 1985, Saudi Arabia abandoned that role. 1985, Saudi Arabia abandoned that role. Since 1987, Saudi Arabia maintained its Since 1987, Saudi Arabia maintained its share in the oil market. share in the oil market.

However, with a decline in prices in 1998, However, with a decline in prices in 1998, a decline in OPECa decline in OPEC’’s spare capacity and s spare capacity and with low growth in non-OPEC supply, with low growth in non-OPEC supply, Saudi Arabia gained more power in the oil Saudi Arabia gained more power in the oil market.market.

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Objective of the paperObjective of the paper

Test the role of Saudi Arabia in the Test the role of Saudi Arabia in the oil market by considering the swing oil market by considering the swing producer model for the period 1997-producer model for the period 1997-2010.2010.

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WhyWhy

Since the mid-nineties as an official policy, Since the mid-nineties as an official policy, Saudi Arabia maintained, excess capacity of Saudi Arabia maintained, excess capacity of 1.5-2 MB/D. 1.5-2 MB/D.

In 2010, oil production capacity was estimated In 2010, oil production capacity was estimated at over 12 MB/D.at over 12 MB/D.

Saudi Arabia’s average production in 2010, 8.2 Saudi Arabia’s average production in 2010, 8.2 MB/D.MB/D.

Saudi Arabia can increase production during Saudi Arabia can increase production during demand surge and market interruption.demand surge and market interruption.

Saudi Arabia can decrease production during Saudi Arabia can decrease production during low oil prices.low oil prices.

Objective: to moderate oil prices. Objective: to moderate oil prices.

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Importance of Saudi Importance of Saudi ArabiaArabia

Has the highest world proven oil reserves, Has the highest world proven oil reserves, 262.5 billion barrels.262.5 billion barrels.

Constitutes 12% of world oil production. Constitutes 12% of world oil production. Is a key crude oil supplier to the United States Is a key crude oil supplier to the United States

(14%), Europe (4%) and Asia (57%) in 2009.(14%), Europe (4%) and Asia (57%) in 2009. Has two primary oil export terminals, in the Gulf Has two primary oil export terminals, in the Gulf

and in the Red Sea.and in the Red Sea. Exports five crude qualities ranging from the 45Exports five crude qualities ranging from the 4500

API Arab Super Light (ASL) to the 23.7API Arab Super Light (ASL) to the 23.700 API Arab API Arab Heavy (AH)Heavy (AH)

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Review of literatureReview of literature Griffin and Teece Griffin and Teece (1982) (1982) Adelman (1982Adelman (1982) )

Dahl and Yucel (1991) Griffin and Neilson Dahl and Yucel (1991) Griffin and Neilson (1994), Alhajji and Huettner (2000) Smith (1994), Alhajji and Huettner (2000) Smith (2005) emphasize on the dominant role (2005) emphasize on the dominant role of Saudi Arabia in OPEC.of Saudi Arabia in OPEC.

Doran (1977Doran (1977)) Moran (1982) Askari (1991) Moran (1982) Askari (1991) Stevens (1991,1995) , Khadduri (1996) Stevens (1991,1995) , Khadduri (1996) political objective behind Saudi Arabiapolitical objective behind Saudi Arabia’’s s policy.policy.

De Santis, and Roberto (2003) claim De Santis, and Roberto (2003) claim profits and welfare are incentives.profits and welfare are incentives.

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Figure 1: OPEC production Figure 1: OPEC production ceiling and oil price $/Bceiling and oil price $/B

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OPEC production Ceiling

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OPEC decisions on production OPEC decisions on production 1997-20101997-2010

With prices close to $20/b, in December 1997, OPEC increased its quota by With prices close to $20/b, in December 1997, OPEC increased its quota by 2.5 MB/D (10%) to 27.5. Decline in demand resulting from the Asian crisis 2.5 MB/D (10%) to 27.5. Decline in demand resulting from the Asian crisis caused the price to fail; it reached $10/b in Dec. 1998caused the price to fail; it reached $10/b in Dec. 1998

In response, OPEC cut quotas 3 times (In April 99, total reduction was 3 In response, OPEC cut quotas 3 times (In April 99, total reduction was 3 MB/D). Prices increased to $25/B.MB/D). Prices increased to $25/B.

Growing world economics: between April and October, 2000, there were three Growing world economics: between April and October, 2000, there were three successive OPEC quota increases totaling 3.2 MB/D.successive OPEC quota increases totaling 3.2 MB/D.

In 2001, a weakened US economy, prices declined OPEC carried out several In 2001, a weakened US economy, prices declined OPEC carried out several reductions, cutting 3.5 MB/d by September 1, 2001. Prices reached $15/B in in reductions, cutting 3.5 MB/d by September 1, 2001. Prices reached $15/B in in Jan 2002, OPEC cut production joined by Russia. Prices reached 26 in Dec Jan 2002, OPEC cut production joined by Russia. Prices reached 26 in Dec 2003.2003.

In 2003, With an improving economy, US demand was increasing and Asian In 2003, With an improving economy, US demand was increasing and Asian demand for crude oil was growing at a rapid pace (China and India). Advanced demand for crude oil was growing at a rapid pace (China and India). Advanced economies proved more resilient to rising oil prices than previously believed. economies proved more resilient to rising oil prices than previously believed.

2004 and 2005, the spare capacity to produce oil was under 1 MB/dD.2004 and 2005, the spare capacity to produce oil was under 1 MB/dD. On April to June 2004, OPEC (excluding Iraq) announced an agreement to On April to June 2004, OPEC (excluding Iraq) announced an agreement to

reduce actual production by 1 MB/d by January 1 reduce actual production by 1 MB/d by January 1 Oil prices peaked in July 2008 at over. $145/barrel for WTI. However, the Oil prices peaked in July 2008 at over. $145/barrel for WTI. However, the

prices declined, because of the financial crisis of 2008/2009. OPEC agreed to prices declined, because of the financial crisis of 2008/2009. OPEC agreed to cut production by 4.2 MB/D after a dramaticcut production by 4.2 MB/D after a dramatic decline in oil prices to below $40.decline in oil prices to below $40.

In 2009 and 2010, OPEC left its production target unchanged. Prices reached In 2009 and 2010, OPEC left its production target unchanged. Prices reached an average of $63/barrel in 2009, and increased in 2010 to reach an average. an average of $63/barrel in 2009, and increased in 2010 to reach an average. $80/barrel.$80/barrel.

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Figure 2: Other OPEC and Saudi Arabia Figure 2: Other OPEC and Saudi Arabia Quotas and actual production (1997 – 2010)Quotas and actual production (1997 – 2010)..

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Figure 3: Saudi Oil Figure 3: Saudi Oil Production and the Market Production and the Market

Price (1997.1 – 2010.12)Price (1997.1 – 2010.12)

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The Swing Producer The Swing Producer ModelModel

Price control means setting an effective Price control means setting an effective transaction price preventing market forces from transaction price preventing market forces from changing it. changing it.

However, high prices will induce competitors to However, high prices will induce competitors to enter the market. enter the market.

A dominant supplier thus has a choice; it can A dominant supplier thus has a choice; it can achieve short run profits by raising price at the achieve short run profits by raising price at the expense of losing its dominance in the future, expense of losing its dominance in the future,

or it can charge a moderate price that supports or it can charge a moderate price that supports its market share and generates high competitive its market share and generates high competitive profits over time. profits over time.

When engaged in the latter strategy, the When engaged in the latter strategy, the dominant supplier will try to lead the market by dominant supplier will try to lead the market by signaling what price it strives to maintain as the signaling what price it strives to maintain as the target price (PT). target price (PT).

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Target PriceTarget Price Since 1987, OPEC set a reference price, which is the OPEC Since 1987, OPEC set a reference price, which is the OPEC

Reference Basket, used as a guideline for determining the Reference Basket, used as a guideline for determining the ceiling of OPEC production. ceiling of OPEC production.

In 1987, the price was $18 per barrel; In 1987, the price was $18 per barrel; In the 1990s, a minimum reference price of $21/b is used.In the 1990s, a minimum reference price of $21/b is used. In June 2000, members of OPEC established a mechanism In June 2000, members of OPEC established a mechanism

to adjust the supply of oil by 500,000 B/D if the 20-day to adjust the supply of oil by 500,000 B/D if the 20-day average price of oil moved outside a $22 to $28 price band. average price of oil moved outside a $22 to $28 price band.

From June 2003 until Nov. 07, no target price was From June 2003 until Nov. 07, no target price was determined determined

but an implicit price resulted from the OPEC decision. Nov. but an implicit price resulted from the OPEC decision. Nov. ‘03 – Mar. ‘04 it was $30. Apr. ‘04 to Mar. ’05, it was $35‘03 – Mar. ‘04 it was $30. Apr. ‘04 to Mar. ’05, it was $35

Apr. ‘05 – Oct. ’06, it was $50. Between Nov. ‘06 and Nov. Apr. ‘05 – Oct. ’06, it was $50. Between Nov. ‘06 and Nov. ’07, it was $70.’07, it was $70.

At the end of 2007 it was announced that the target price of At the end of 2007 it was announced that the target price of OPEC was $75OPEC was $75

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The ModelThe Model Saudi Arabia manipulated its production in Saudi Arabia manipulated its production in

order to minimize the difference between the order to minimize the difference between the target price Ptarget price PTT and the market price P and the market price PMM. . However, it was not concerned about the However, it was not concerned about the absolute value; it was concerned about the absolute value; it was concerned about the proportionate difference. Thus, the objective proportionate difference. Thus, the objective function is (Pfunction is (PTT/P/PMM) keeping the difference ) keeping the difference between both prices equal to zerobetween both prices equal to zero

If the demand were high for OPEC oil (PIf the demand were high for OPEC oil (PTT/P/PMM)<1, )<1, Saudi Arabia would increase its outputSaudi Arabia would increase its output

If demand were low for OPEC oil, Saudi Arabia If demand were low for OPEC oil, Saudi Arabia would decrease its output (Pwould decrease its output (PTT/P/PMM)>1)>1

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M

T

P

P

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ModelModel

Using the notation PUsing the notation PTMTM=(P=(PTT/P/PMM)) َ�َ�QQSASA=f(P=f(PTMTM)) Saudi Arabia is a member of OPEC, Saudi Arabia is a member of OPEC,

so its production is also a proportion so its production is also a proportion of total OPEC production of total OPEC production

QQSASA=f(Qoo,P=f(Qoo,PTMTM))

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DataData Source: OPEC secretariat Source: OPEC secretariat Monthly Data from 1997.1 – 2010.12, Monthly Data from 1997.1 – 2010.12,

n=168n=168 Production DataProduction Data from six sources (Petroleum from six sources (Petroleum

Argus, Reuters, Petroleum Intelligence Weekly Argus, Reuters, Petroleum Intelligence Weekly (PIW), Platt(PIW), Platt’’s Oilgram Price Report, s Oilgram Price Report, International energy Agency (IEA), Middle International energy Agency (IEA), Middle East Economic Survey (MEES), East Economic Survey (MEES), Petrostrategies, taking a simple average of the Petrostrategies, taking a simple average of the estimation of those sources of OPEC membersestimation of those sources of OPEC members’’ actual production. We will rely on this data for actual production. We will rely on this data for that period as reported by OPEC secretariat. that period as reported by OPEC secretariat.

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Price DataPrice Data

The Market PriceThe Market Price: the OPEC : the OPEC Reference Basket Reference Basket

The Target Price:The Target Price: determined by determined by OPECOPEC

Source: OPEC secretariatSource: OPEC secretariat

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Method of analysisMethod of analysis

Using the autoregressive distributed Using the autoregressive distributed lag (ARDL) cointegration procedure lag (ARDL) cointegration procedure introduced by introduced by Pesaran et al. (2001), Pesaran et al. (2001), we test for the null of no we test for the null of no cointegration against the existence cointegration against the existence of a long-run relationshipof a long-run relationship

Estimate the error correction Estimate the error correction representation of the ARDL model representation of the ARDL model

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ResultResultLong-run relationshipLong-run relationship lnQsa=12.44-0.34lnQoo-0.46lnPlnQsa=12.44-0.34lnQoo-0.46lnPTMTM+e+e t-value -0.68[0.495] -2.5[0.013]t-value -0.68[0.495] -2.5[0.013] For a swing producer role β3≠ 0, which means the For a swing producer role β3≠ 0, which means the

difference between the Saudi price and the market price difference between the Saudi price and the market price has an influence on the Saudi output decisionhas an influence on the Saudi output decision

When the ratio between (PWhen the ratio between (PTT, P, PMM) decreases, Saudi Arabia ) decreases, Saudi Arabia would increase its production to lower Pwould increase its production to lower PMM. When the ratio . When the ratio increases (Pincreases (PTT.P.PMM), Saudi Arabia would decrease its ), Saudi Arabia would decrease its production to increase Pproduction to increase PMM

ß<0 that is Saudi Arabia has a negative relationship with ß<0 that is Saudi Arabia has a negative relationship with the production of other members of OPEC, which shows the production of other members of OPEC, which shows we have cartel behavior with Saudi Arabia acting as the we have cartel behavior with Saudi Arabia acting as the swing producer swing producer

However, it is not significantHowever, it is not significant

]013.0[51.2]495.0[68.0]013.0[49.2

ln46.0ln34.044.12ln

valuet

uPQQ tTMOO

tSAt02

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Error correction Error correction representation for the representation for the

selected ARDLselected ARDLcoefficient-valuecoefficient-valuet-valuet-value

interceptintercept 0.0005600.000560....4949.].]961961[[

ΔΔQsaQsat-1t-10.367 0.367 5.26[000] 5.26[000]

ΔΔQooQoott0.096 0.096 1.79[.075] 1.79[.075]

ΔΔQooQoot-1t-1-0.068 -0.068 1.273[.205] 1.273[.205]

ΔΔPPTMTMtt--0.0310.031 --2.7962.796.[.[005005 ] ]

ΔΔPPTMTMtt1-1-0.0180.018-- --1.3711.371.[.[172172 ] ]

ΔΔPPt2t2----0.0230.023 --2.0332.033.[.[044044 ] ]

ECMECMt-1t-1--0.0300.030 --2.4012.401.[.[010177 ] ]

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Error Correction ModelError Correction Model

ECMECMt-1t-1

The speed of adjustment itself, The speed of adjustment itself, which is 3%, indicates a low rate of which is 3%, indicates a low rate of convergence to equilibrium. The convergence to equilibrium. The larger the error correction larger the error correction coefficient, the faster the economy coefficient, the faster the economy returns to its equilibrium, once returns to its equilibrium, once shocked. shocked.

Short-run elasticity 0.07 and 0.03 Short-run elasticity 0.07 and 0.03

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ElasticitiesElasticitiesfor the model (1997–2010)for the model (1997–2010)

comparison with swing producer comparison with swing producer for Saudi Arabia (for Saudi Arabia (1976–1985)1976–1985)

OPECOPEC

OthersOthersPPTMTM

Long-Run Long-Run ElasticityElasticity

--0.340.34

--1.441.44

--0.460.46

--0.870.87

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ConclusionConclusion

Saudi Arabia has a significant role in Saudi Arabia has a significant role in the oil market. It changes its the oil market. It changes its production in order to stabilize the production in order to stabilize the price of oil, we can say the Swing price of oil, we can say the Swing Producer Model is partially Producer Model is partially applicable to Saudi Arabia because applicable to Saudi Arabia because the kingdom changed its production the kingdom changed its production in order to keep oil prices stable in order to keep oil prices stable

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Thank YouThank You