THE DOMINANT ROLE OF
SAUDI ARABIA IN THE OIL
MARKET 1997-2010
Nourah AlYousef
Associate Professor of Economics.
King Saud University.
alyousefn@yahoo.com
1
Saudi Arabia and the oil market


Saudi Arabia played an effective part for the period
1974-1985, where it had the title role in the Swing
Producer Model. In 1985, Saudi Arabia abandoned that
role. Since 1987, Saudi Arabia maintained its share in
the oil market.
However, with a decline in prices in 1998, a decline in
OPEC’s spare capacity and with low growth in nonOPEC supply, Saudi Arabia gained more power in the
oil market.
2
Objective of the paper

Test the role of Saudi Arabia in the oil market
by considering the swing producer model for the
period 1997-2010.
3
Why






Since the mid-nineties as an official policy, Saudi Arabia
maintained, excess capacity of 1.5-2 MB/D.
In 2010, oil production capacity was estimated at over
12 MB/D.
Saudi Arabia’s average production in 2010, 8.2 MB/D.
Saudi Arabia can increase production during demand
surge and market interruption.
Saudi Arabia can decrease production during low oil
prices.
Objective: to moderate oil prices.
4
Importance of Saudi Arabia





Has the highest world proven oil reserves, 262.5 billion
barrels.
Constitutes 12% of world oil production.
Is a key crude oil supplier to the United States (14%), Europe
(4%) and Asia (57%) in 2009.
Has two primary oil export terminals, in the Gulf and in the Red
Sea.
Exports five crude qualities ranging from the 450 API Arab
Super Light (ASL) to the 23.70 API Arab Heavy (AH)
5
Review of literature



Griffin and Teece (1982) Adelman (1982) Dahl and Yucel
(1991) Griffin and Neilson (1994), Alhajji and Huettner
(2000) Smith (2005) emphasize on the dominant role
of Saudi Arabia in OPEC.
Doran (1977) Moran (1982) Askari (1991) Stevens
(1991,1995) , Khadduri (1996) political objective behind
Saudi Arabia’s policy.
De Santis, and Roberto (2003) claim profits and welfare
are incentives.
6
Figure 1: OPEC production ceiling
and oil price $/B
160
32000
140
30000
120
Price
OPEC production Ceiling
28000
80
26000
MB/D
$/B
100
60
24000
40
22000
20
0
Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul97 97 98 98 99 99 00 00 01 01 02 02 03 03 04 04 05 05 06 06 07 07 08 08 09 09 10 10
20000
7
OPEC decisions on production 19972010









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 caused 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 MB/D). Prices increased
to $25/B.
Growing world economics: between April and October, 2000, there were three successive OPEC
quota increases totaling 3.2 MB/D.
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 Jan 2002, OPEC cut production
joined by Russia. Prices reached 26 in Dec 2003.
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 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.
On April to June 2004, OPEC (excluding Iraq) announced an agreement to reduce actual
production by 1 MB/d by January 1
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 cut production by 4.2 MB/D after a
dramatic decline in oil prices to below $40.
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. $80/barrel.
8
n97
Ju
l-9
Ja 7
n98
Ju
l-9
Ja 8
n99
Ju
l-9
Ja 9
n00
Ju
l-0
Ja 0
n01
Ju
l-0
Ja 1
n02
Ju
l-0
Ja 2
n03
Ju
l-0
Ja 3
n04
Ju
l-0
Ja 4
n05
Ju
l-0
Ja 5
n06
Ju
l-0
Ja 6
n07
Ju
l-0
Ja 7
n08
Ju
l-0
Ja 8
n09
Ju
l-0
Ja 9
n10
Ju
l-1
0
Ja
thousan barrel per day
Figure 2: Other OPEC and Saudi Arabia Quotas and actual
production (1997 – 2010).
35,000.00
KSA Production
OPEC Production
KSA Quota
OPEC Ceiling
30,000.00
25,000.00
20,000.00
15,000.00
10,000.00
5,000.00
0.00
9
Figure 3: Saudi Oil Production and
the Market Price (1997.1 – 2010.12)
160
10,000.00
Price
140
production
9,500.00
120
9,000.00
100
8,500.00
80
8,000.00
60
7,500.00
40
7,000.00
20
6,500.00
0
Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul97 97 98 98 99 99 00 00 01 01 02 02 03 03 04 04 05 05 06 06 07 07 08 08 09 09 10 10
6,000.00
10
The Swing Producer Model





Price control means setting an effective transaction price
preventing market forces from changing it.
However, high prices will induce competitors to enter the
market.
A dominant supplier thus has a choice; it can achieve short run
profits by raising price at the expense of losing its dominance in
the future,
or it can charge a moderate price that supports its market share
and generates high competitive profits over time.
When engaged in the latter strategy, the dominant supplier will
try to lead the market by signaling what price it strives to
maintain as the target price (PT).
11
Target Price








Since 1987, OPEC set a reference price, which is the OPEC Reference
Basket, used as a guideline for determining the ceiling of OPEC production.
In 1987, the price was $18 per barrel;
In the 1990s, a minimum reference price of $21/b is used.
In June 2000, members of OPEC established a mechanism 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.
From June 2003 until Nov. 07, no target price was determined
but an implicit price resulted from the OPEC decision. Nov. ‘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. ’07, it was $70.
At the end of 2007 it was announced that the target price of OPEC was $75
12
 PT

 PM


 1


The Model



Saudi Arabia manipulated its production in order to
minimize the difference between the target price PT and
the market price PM. However, it was not concerned
about the absolute value; it was concerned about the
proportionate difference. Thus, the objective function
is (PT/PM) keeping the difference between both prices
equal to zero
If the demand were high for OPEC oil (PT/PM)<1,
Saudi Arabia would increase its output
If demand were low for OPEC oil, Saudi Arabia would
decrease its output (PT/PM)>1
13
Model




Using the notation PTM=(PT/PM)
َQSA=f(PTM)
Saudi Arabia is a member of OPEC, so its
production is also a proportion of total OPEC
production
QSA=f(Qoo,PTM)
14
Data



Source: OPEC secretariat
Monthly Data from 1997.1 – 2010.12, n=168
Production Data from six sources (Petroleum Argus,
Reuters, Petroleum Intelligence Weekly (PIW), Platt’s
Oilgram Price Report, International energy Agency
(IEA), Middle East Economic Survey (MEES),
Petrostrategies, taking a simple average of the
estimation of those sources of OPEC members’ actual
production. We will rely on this data for that period as
reported by OPEC secretariat.
15
Price Data

The Market Price: the OPEC Reference
Basket
The Target Price: determined by OPEC

Source: OPEC secretariat

16
Method of analysis


Using the autoregressive distributed lag (ARDL)
cointegration procedure introduced by Pesaran
et al. (2001), we test for the null of no
cointegration against the existence of a long-run
relationship
Estimate the error correction representation of
the ARDL model
17
 2QtSA0  12.44  0.34 ln QtOO  0.46 ln P TM  ut
ln
t  value 2.49[0.013]  0.68[0.495]  2.51[0.013]
Result
Long-run relationship
 lnQsa=12.44-0.34lnQoo-0.46lnPTM+e
 t-value -0.68[0.495] -2.5[0.013]
 For a swing producer role β3≠ 0, which means the difference
between the Saudi price and the market price has an influence on
the Saudi output decision
 When the ratio between (PT, PM) decreases, Saudi Arabia would
increase its production to lower PM. When the ratio increases
(PT.PM), Saudi Arabia would decrease its production to increase
PM
 ß<0 that is Saudi Arabia has a negative relationship with the
production of other members of OPEC, which shows we have
cartel behavior with Saudi Arabia acting as the swing producer
 However, it is not significant
18
Error correction representation for
the selected ARDL
coefficient-value
intercept
ΔQsat-1
ΔQoot
ΔQoot-1
ΔPTMt
ΔPTMt-1
ΔPt2ECMt-1
0.000560.
0.367
0.096
-0.068
-0.031
-0.018
-0.023
-0.030
t-value
.49[.961]
5.26[000]
1.79[.075]
1.273[.205]
-2.796[.005]
-1.371[.172]
-2.033[.044]
-2.401[.017]
19
Error Correction Model
ECMt-1
 The speed of adjustment itself, which is 3%,
indicates a low rate of convergence to
equilibrium. The larger the error correction
coefficient, the faster the economy returns to its
equilibrium, once shocked.
 Short-run elasticity 0.07 and 0.03
20
Elasticities
for the model (1997–2010)
comparison with swing producer for Saudi
Arabia (1976–1985)
Long-Run
Elasticity
OPEC
Others
PTM
-0.34
-1.44
-0.46
-0.87
21
Conclusion

Saudi Arabia has a significant role in the oil
market. It changes its production in order to
stabilize the price of oil, we can say the Swing
Producer Model is partially applicable to Saudi
Arabia because the kingdom changed its
production in order to keep oil prices stable
22
Thank You
23