Saudi Arabia stopped supporting higher oil prices after Donald Trump said higher prices “will not be accepted.”
The world’s largest oil exporter was said to have planned to move oil prices up to $100 a barrel but now appears to have decided that prices should not move higher than $80 a barrel.
Oil prices fell Friday, sending shares of oil producers and refiners lower and airline shares higher after Saudi Oil Minister Khalid al-Falih said his country shared the “anxiety” of his customers over the rising price of oil. He went on to announce that the Organization of Petroleum Exporting Countries would likely boost its output in the second half of the year.
All this follows a April 20th tweet from President Trump decrying the “artificially Very High” price of oil.
Trump is one of the few politicians in Washington, D.C. who has exhibited an understanding of how global oil prices are set. The Saudis do not sell at spot prices like the rest of the world’s oil producers. Instead, they post their prices to refiners and then fill all orders at the set price. The rest of the world buys all the oil available at spot prices, then buys the rest of what it needs from the Saudis at the fixed price. As a result, the supply of Saudi oil grows or shrinks in response to demand at the fixed price. This makes them, more or less, the price setter or swing supplier of oil.
If the Saudis want the price of oil to fall, they simply set their own price below the current market levels. This pushes down the spot price because refiners will not bid much above the Saudi fixed price. When the Saudis decide world prices are at the “right” level, they simply post prices near that level.
Trump understands that too high of an oil price, particularly during the summer driving months, acts as a tax on U.S. consumers. It forces U.S. households to spend more of their income on gasoline, and ultimately results in demand leakage across the economy as U.S. income is diverted to foreign oil suppliers. This effect has been somewhat ameliorated by the shale oil boom, which means that a greater share of energy spending stays inside the U.S. What’s more, higher oil prices can—over a long enough time period—encourage investment in U.S. extraction, which adds to the U.S. economy.
But Trump wants robust economic growth now and does not want to see a spike in oil prices undermine the stimulus provided by his tax cuts. So he used twitter to send a message to Saudi Arabia and now the Saudis have responded by bringing down the price of oil.
“The tweet moved the Saudis,” Bob McNally, founder of consultant Rapidan Energy Group LLC in Washington and a former White House oil official, told Bloomberg. “The message was delivered loud and clear to Saudi Arabia.”
Of course, the Saudis want the world oil market to operate smoothly. They try to keep the other oil producing nations apprised of their plans, which keeps any resentment of the Saudi price-setting role at a minimum and actually means that the Saudis do not actually have to push around oil prices all that much. Their OPEC partners do it for them by adjusting their own supplies in anticipation of Saudi pricing. People often describe OPEC as a price-setting oligopoly, but it is more like a communication forum where the monopoly price setter tells its price taking partners what to expect.
The closest example to this is probably the Federal Reserve’s rate targeting. Officially, the Federal Reserve does not “fix” the price of overnight borrowing. Instead, it targets a rate and promises to intervene in the market by supplying or withdrawing bank reserves to keep the price near target. But, in practice, the Fed does not have to intervene all that often.
Al-Falih’s comments about rising oil supplies came after meeting with Russia’s top oil official in St. Petersburg, where he likely explained the Saudi plans in advance. The Russians know very well the Saudis set the price—and at this point have little incentive to attempt to convince the Saudis to abandon their plans to go along with Trump’s desire to halt price hikes. The pain of falling prices will be eased as more demand shifts to Russia and other suppliers as a result of chaos in Venezuela and the return of sanctions on Iran.
Crude fell from $70 to $67 a barrel in New York on Friday.