Last month, following a collapse in the price of Brent crude to a four-year low, Saudi Arabia and its OPEC-plus partners announced their second consecutive monthly supply hike. Doubtless this will be seen in some quarters as an attempt to please President Trump, who promised his voters cheaper oil and recently praised the Saudi crown prince as “an incredible man” and “great guy.” Others will likely see it as a strategic blunder. Both interpretations on this apparently ill-timed decision are misguided.
To understand why, we have to go back to 2020.
Our real-time satellite monitoring of oil inventories had shown that the world was rapidly running out of space to store the crude oil that, thanks to the inertia caused by COVID-19 and the lockdowns, was no longer wanted at the same rate. Yet soon after the world went into lockdown, Saudi Arabia and Russia initiated an oil price war. It was widely received as a spectacular blunder, but my colleagues and I at Kayrros suspected there might be some method to the madness.
Using the principles of game theory, our team, which includes Fields Medal laureate Pierre-Louis Lions and Jean-Michel Lasry, developed the Edmond model. This showed that to make as much money as possible, big low-cost producers such as Saudi Arabia had to strike a balance between selling at the highest price and having the greatest market share.
Though OPEC may say its job is to keep prices stable, in fact the market swings up and down. When prices are up, Saudi Arabia and others make more money, but the smaller, higher-cost producers also start pumping more oil in an attempt to cash in. That extra supply, eventually, leads to price crashes.
The big players know this. So after letting others flood the market, they strike back. They open the taps, flood the market themselves, and crash prices on purpose. The worse the crash, the more damage is done to the smaller players. The goal for the big players is to force their smaller rivals out.
The fall in oil demand and subsequent price crash caused by COVID was worse than ever. Russia and Saudi Arabia saw this as a chance to push the system to its limits and see how much oil the world could physically store. With inventories full, prices went negative. Weaker competitors were squeezed out. Many U.S. shale producers went bankrupt. And both Saudi and Russia increased their power in the oil market.
These crashes tend to need a trigger. In 2020, it was COVID-19. But in the late 1990s, it was the Asian financial crisis. In 2014, it was the U.S. shale oil boom. Today, the volatility caused by the policies of the U.S. administration marks another such trigger. With the supply of U.S. crude rising, and with some of the smaller OPEC-plus members flouting quotas, Riyadh again seems to be preparing to act. As the Edmond model showed, it is worth Saudi Arabia enduring short-term pain to consolidate its share of the market, force out smaller rivals and send a message to any future competitors.
What makes these circumstances different is that Trump has actively called for OPEC to increase its supply so that he can satisfy the desire among American voters for cheaper oil. In other words, he has given his counterparts in Riyadh a license to crash the market. Should prices keep falling, this would force U.S. oil companies to stop producing, and for a lengthy period. If markets are expecting a rally, or even stability, they are likely to be disappointed.
And at the end of it all, Saudi Arabia, the great masters of the oil game, will be just where they want to be.
Antoine Rostand is co-founder and president of global climate technology company Kayrros, where co-founder Antoine Halff serves as chief analyst.
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