Saudi Arabia - the ‘dominant producer’ in the world’s oil market

Saudi Arabia’s position as one of the largest players in the global oil market, producing more than a tenth of the world’s output and owning a quarter of the world’s proven reserves, has negative effects on other market participants. Writing in the Economic Journal, Anton Nakov and Galo Nuño document two features that have made the Kingdom different from other oil producers:

1. Output squeeze: First, it systematically restricts its production. In fact, its spare capacity is much larger than the aggregate spare capacity of the rest of the world’s oil producers.
2. Volatile supply: Second, its production is quite volatile. The variance of Saudi oil output has been very high compared with that of the other producers, even though the Kingdom itself has witnessed few domestic shocks affecting oil production directly.

The Kingdom is a key member of OPEC (Organization of Petroleum Exporting Countries), playing a central role in its decision-making. Indeed, some economists have argued that ‘OPEC is Saudi Arabia’ and that ‘the Saudis have acted as what they are: the leading firm in the world oil market’. Are these claims exaggerations?

Nakov and Nuño show that it is possible to explain the behaviour of Saudi Arabia as that of a dominant producer operating alongside a competitive fringe. They build an analytical model in which a dominant oil supplier anticipates the behaviour of both fringe oil producers and oil consumers.

This means that Saudi Arabia exploits the fact that its operations affect the supply of fringe producers, oil demand and the oil price. The result is that Saudi Arabia produces a smaller amount of oil than its capacity given the oil price, which allows it to charge a high mark-up over its marginal cost.

Saudi_Oil_Charts.pptx