King Abdullah's death and the 'fear premium' in Saudi oil markets

Published January 25th, 2015 - 01:12 GMT

Oil prices reacted, almost immediately and violently, to the news of the death of the Custodian of the Two Holy Mosques King Abdullah Bin Abdulaziz, the ruler of the world’s largest crude exporter and OPEC kingpin Saudi Arabia for almost a decade.

The passing of King Abdullah in the early hours of Friday led to speculation that a leadership transition could result in a change to the country’s oil policy and strategy. In recent months, OPEC has opted to continue pumping oil in a bid to defend market share rather than cut production and bolster prices. And Saudi Arabia has been the force behind this decision. Some hence questioned: would Saudi Arabia reverse its policy of insisting on market share in aftermath of the change at the top in Riyadh?

In fact oil prices had tumbled further on Thursday, before the death of the King, after the European Central Bank announced a bigger-than-expected €1.1 trillion bond-buying program aimed at kick-starting the eurozone economy. But news of the King’s death early on Friday sparked a rally, as uncertainty gripped markets, adding a fear premium to the otherwise bottoming crude market prices.

The benchmark US crude futures contract rose more than $2 a barrel in the hours after the King’s death Thursday evening in New York. But by the time commodity markets opened Friday those gains had been largely erased. In morning trading on Friday, US oil was up 18 cents to $46.49 a barrel, while Brent was up 80 cents to $49.32 a barrel in London. The limited rise in US crude was attributed to a reported buildup of inventory at the Cushing, Oklahoma storage hub and the partial shutdown of an Indiana refinery. A trader said energy data provider Genscape estimated that US crude stockpiles in Cushing, Oklahoma, rose 1.7 million barrels in the week ending Tuesday.

Reports of the partial shutdown at BP’s oil refinery in Whiting, Indiana, also weighed further on US crude. Reports quoting sources familiar with the plant’s operations said they did not know when the 90,000-barrel-per-day (bpd) crude distillation unit would be restarted.

This helped widen the spread between WTI and Brent.

However, as expected by most, the spike was only temporary. It had not much to do with fundamentals. Oil prices slipped Friday as investors bet that a change in Saudi Arabia’s leadership was unlikely to alter the kingdom’s oil-market policy. The US oil benchmark, which had risen as much as 3.1 percent in overnight trading, turned negative during the morning session, down 21 cents, or 0.4 percent, at $46.10 a barrel on the New York Mercantile Exchange.

The smooth transition in Riyadh also helped stabilize the markets. Immediately after taking over, King Salman nominated Prince Muqrin as the Crown Prince. Later in the day on Friday, through a of royal decree, Prince Mohammed bin Naif Bin Abdulaziz was nominated as the deputy crown prince - inducting a grandson of King Abdulaziz directly into the line of throne.

The small rise in oil market prices reflected the impact of the transition in Riyadh on the Saudi oil policy.

King Salman’s rapid moves helped clearing the air. Continuity and stability would be the hallmark of his reign, he underlined. Addressing the nation, King Salman made it clear  there would be no major deviations from the past. “We will, with God’s support, maintain the straight path that this country has advanced on since its establishment by the late King Abdulaziz,” the new King said in a speech broadcast on state television.

The air of uncertainty began to disappear. “There is no tangible evidence to suggest that Saudi Arabia will veer away from existing policy of keeping oil output steady in the face of growing US shale oil supply,” Harry Tchilinguirian, head of commodity markets strategy at BNP Paribas SA, was quoted as saying, adding, King Salman “was already actively involved in policy-making.”

“There’s still an overwhelming glut of supply in global markets,” Stephen Schork, president of Schork Group in Villanova, Pennsylvania told the press. “Certainly this death matters but it doesn’t fundamentally change anything. The Saudis are trying to preserve market share and have been quite clear about that.”

Also with the new King continuing to back the veteran Oil Minister Ali Al-Naimi, any possibility of Naimi finally hanging his boots also disappeared. Any hint about the possible departure of   Naimi, the architect of the Kingdom’s current crude policy from the scene would have been a source of uneasiness in the markets. “Naimi is a market-calming voice, and very well-respected,” Frank Verrastro of the Center for Strategic and International Studies was quoted as saying. “Naimi will likely stay on during this period of uncertainty.”

With no changes in the oil ministry, the uncertainty factor receded further. Most analysts hence reached the conclusion that there would not be any major change in the kingdom’s oil policy - any time soon. And they had their reasons too. “There will be no change in Saudi’s policy whatsoever,” Julian Jessop, global chief economist at Capital Economics was quoted as saying. Analysts now think Saudi production won’t be lowered anytime soon.

And thus the current oil policy, crystallized during the Abdullah era, is all set to continue. In the ongoing battle for market share, Saudi Arabia is not going to blink first. While admitting that Saudi Arabia, deriving 90 percent of its budget from oil and is feeling the pain of the price collapse, Prince Al-Waleed bin Talal, chairman of Kingdom Holdings, speaking to CNBC after the death of King Abdullah, underlined that Saudi Arabia would not be the first to blink. “There’s a game of who should cut production first” between members of the oil organization and non-OPEC nations. “Eventually there’s no doubt that some countries have to blink and reduce their production. ... I don’t see Saudi Arabia or the OPEC countries blinking,” he added authoritatively.

Despite the change at top in Riyadh, crude markets are expected to continue to be faced with weak fundamentals, at least for some more time to come. Prices could be in for some more battering in the coming weeks. The transition is not going to make much difference - as far as Saudi oil policies are concerned.


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