What Saudi King Abdullah's death could mean for oil prices

Saudi Arabia is the world's second-largest producer of crude oil. So the news that the country's King Abdullah has died certainly has the potential to shake up global oil markets. Already, there are signs of (small) jitters: Shortly after Abdullah's death was announced on state television, the price of West Texas Intermediate crude traded in the United States jumped roughly 2 percent, to $47 per barrel. The key question that will be on everyone's mind is whether Saudi Arabia might alter its controversial policy of keeping oil output high even as the rest of the world is oversupplied with crude. This policy has helped pushed global oil prices down over the last few months. But those low prices are also putting a dent in the country's budget, and the stance has attracted criticism from some members of the royal family. In the short term, analysts say it's unlikely we'll see a huge shift following King Abdullah's death — especially since the newly announced king, Salman bin Abdel-Aziz, has explicitly backed the country's oil policy. Still, this is a story worth keeping an eye on, not least since Salman is himself 79 years old. "In my view, we're not going to see a big change in Saudi oil policy [with the new president]," said Bob McNally, a former White House official and now head of Rapidan Group, a Washington-based consultancy. "But there may be some uncertainty and commotion in terms of what will come next."

Saudi Arabia's recent policies have helped keep oil prices low

To understand what's going on, we have to go back to November of last year. At the time, global oil prices were already falling due to soaring production in the United States and Canada, coupled with sagging demand in places like Europe and Asia. Basically, the world had far more oil than it needed, and prices were sliding as a result. That brought us to OPEC's big meeting on November 27. At the time, many observers wondered whether the cartel — which produces 40 percent of the world's oil — might cut back on its output to prop up prices. After all, countries like Iran, Iraq, and Venezuela need high oil prices to balance their budgets. But Saudi Arabia, the cartel's largest producer, refused to cut back on output. Saudi officials didn't want to surrender market share. Instead, they were hoping that the decline in prices would throttle high-cost oil producers in the US and Canada. (It costs far more to extract oil from shale formations in Texas and North Dakota than it does to pump oil from Saudi Arabia's oil fields.) Once Saudi Arabia announced that they would maintain output, global prices crashed even further — eventually tumbling down to their current level of below $50 per barrel. That's the reason why gasoline in the United States is now the cheapest it's been since 2009. In the months that followed, Saudi Arabia's officials have reiterated support for this policy. In December, the country's oil minister, Ali al-Naimi, said he didn't care if prices crashed to $20 or $40 per barrel, he wasn't going to budge from his position. "It is not in the interest of OPEC producers to cut their production, whatever the price is," he said. But this stance has been controversial with some members of the Saudi royal family. After all, the country needs oil prices around $80 per barrel or so in order to balance its budget. Citigroup has predicted that the Saudi government may have to cut back on social spending this year — spending that was put in place to tamp down on unrest after the Arab Spring. And, while the kingdom has built up $750 billion in foreign reserves to finance those deficits, the whole situation makes some Saudis nervous. "The big fear, or let's say the big disaster, is that the ministry will continue withdrawing from the state financial reserves until they are totally depleted as was the case long time ago, when we were forced to borrow from abroad," wrote Prince Al Waleed bin Talal, a member of the royal family, in a letter in January. And one of Abdullah's (many) sons, an assistant minister for petroleum affairs, was reportedly not a fan of the country's decision to maintain output. But through it all, King Abdullah stood behind Naimi — and his policy to maintain Saudi output. Which raises the question: What happens now that Abdullah is gone?

Why the Saudis might keep their oil policies in place

McNally, for his part, thinks it's unlikely that Saudi Arabia will see a massive shift in oil stance even without Abdullah — at least in the short term. The Saudis quickly announced that the new king will be Abdullah's brother Salman bin Abdulaziz — and he appears to support the country's current oil policy. Back on January 6, Salman delivered the nation's "state-of-the-kingdom" address in which he said that the country would show a "firm will" even as oil prices tumbled. "This is now state policy," McNally said. "Naimi wouldn't be freelancing on his own." One reason that Saudi Arabia might continue to maintain output — even though low prices are hurting their budget — is that they don't really have any other great options. If Saudi Arabia were to cut back on production, prices might remain low anyway. In that case, all that would happen is that the Saudis would lose market share to rival countries like Iran. (Indeed, this is exactly what happened when Saudi Arabia cut back on production in the 1980s in a failed attempt to prop up prices.) That all said, any change in leadership always creates some uncertainty — especially since the new king Salman is already 79 and reportedly in poor health himself. (The next member in line is a half-brother, Muqrin.) So it's entirely possible that further unexpected changes could be on the way.

Further reading

Why oil prices keep falling — and throwing the world into turmoil Saudi Arabia's King Abdullah is dead. He left his successors with a lot of problems.