Neil Barnett writes: This week the International Energy Agency cut its demand growth forecast. In combination with still-growing US production and Saudi determination to keep prices low, it means that prices next year are likely to fall yet further. Today Brent crude was trading at $63.12/barrel – a fall of 40% since July.

This seems extraordinary and there are some who doubt how much further oil can fall. But it is worth remembering that in the early 2000s oil was under $10/barrel. It might not fall so far this time, but it would be a brave trader who bet on a floor having been reached.

The reasons for this drop in prices are numerous, including weak demand and unexpectedly strong production in places like Libya and Iraq. But there is no doubt that low prices are a Saudi policy, as seen in the Kingdom’s continued practice of discounting below the market price and its equanimity at the OPEC conference in late November. The question, then, is why the Saudis are taking this position.

The policy can best be described as a rope with several strands. Since Saudi has modest military power (not to be confused with vast military spending), its influence on oil prices is its best means of shaping the world. At this point low prices serve Saudi strategic interests in the following, inter-related ways: [Continue reading…]