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.

In the short term, Saudi oil policy is unlikely to change much

Already, there are signs of jitters: Shortly after Abdullah's death was announced on Wednesday, the price of West Texas Intermediate crude jumped 2 percent, to $47 per barrel.

One key question on everyone's mind is whether Saudi Arabia might alter its policy of keeping oil output high even as the rest of the world is oversupplied with crude. This controversial stance has helped drive global oil prices down over the last few months. But those low prices are also squeezing Saudi Arabia's budget — and the policy has attracted criticism from some members of the royal family.

For now, that oil policy will stay in place. The new king, Salman bin Abdulaziz, announced on state television Wednesday that he had no plans to change Saudi Arabia's oil stance. What's more, Oil Minister Ali al-Naimi — the man most associated with the current oil strategy — will remain in his post for the time being.

Still, this is a story worth keeping an eye on, not least since Salman is already 79 years old, and the next in line, Crown Prince Muqrin, is 69. And it's wildly unclear how further succession will play out after that.

"In my view, we're not going to see a big change in Saudi oil policy [with King Salman]," said Bob McNally, a former White House official and now head of Rapidan Group, a Washington-based consultancy. "But I expect there will be some uncertainty and commotion in terms of who will come next."

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

Joss Fong/Vox

Spot price of Brent crude as of January 5, 2015 (Joss Fong/Vox)

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 plummeting as a result.

When Saudi Arabia refused to cut back on output, oil prices slid even further

That brought us to OPEC's big meeting on November 27. At the time, many observers wondered whether the cartel — which pumps out 40 percent of the world's oil — might lower its production in order to prop up prices. After all, countries like Iran, Iraq, and Venezuela need high oil prices to balance their budgets.

But Saudi Arabia, OPEC's largest producer, refused to cut back. Saudi officials didn't want to surrender market share. Instead, they were hoping that the decline in crude 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 crude 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 Naimi's stance has been controversial among some members of the Saudi royal family. After all, the country needs oil prices at around $80 per barrel or so to balance its budget. Citigroup recently predicted that the Saudis may soon have to cut back on government spending — spending that had been 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 any deficits for now, 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. Likewise, one of Abdullah's (many) sons, an assistant minister for petroleum affairs, was reportedly not a fan of the decision to keep output high.

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?

The Saudis will keep their oil policies in place — for now

Saudi Arabia's new king, Salman Bin Abdulaziz Al Saud, pictured here in September 1, 2014 meeting with French president Francois Hollande. (Andalou Agency/Getty Images)

In the short term, it's very unlikely that Saudi Arabia will change its oil stance.

The Saudis quickly announced that the new king will be Abdullah's brother Salman bin Abdulaziz. And one of Salman's first acts was to reassure markets that the country's oil policy will remain in place. What's more, Naimi, the key architect of the oil policy, will remain in his post for now. (Although Naimi has said he would like to step down at some point.)

Salman's remarks shouldn't have been a huge surprise. Back on January 6, when Abdullah was ill, Salman had delivered the nation's "state-of-the-kingdom" address in which he said that the country should display a "firm will" even as oil prices tumbled. That was widely seen as a clear endorsement of Naimi's strategy.

Back on Jan. 6, Salman publicly endorsed the current oil stance

"This is now state policy," McNally said. "Naimi wouldn't be freelancing on his own."

One reason that the Saudis would want to maintain their current oil stance — 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 stay low anyway. In that case, all that would happen is that the Saudis would lose market share to competitors like Iran or Iraq — while still facing a hole in their budget. (Indeed, this is basically what happened when Saudi Arabia cut back on production in the early 1980s in a failed attempt to stop prices from crashing.)

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 in line, Crown Prince Muqrin, is 69. And no one really knows how the line of succession will actually play out after that. So it's very possible that further unexpected changes could be on the way.

Note: This story has been updated to reflect Salman's comments that he would not change his predecessor's oil production policies.

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.

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