Saudis no longer control the oil market

Moreover, the price drop over the last three months has not generated any fall in production. On the basis of standard economic theory, a fall in prices should stimulate demand. But the oil market is a special place, where production costs are much disguised by consumer taxes or subsidies.

We are not likely to see a dramatic effect on demand as a result of what has happened - not least because in the US, Europe and Japan oil demand is in structural decline. The only action that would break this trend is a sharp and sustained cut in Saudi output. Saudi Arabia has acted in this way in the past but never alone. Its cuts have always been part of a strategy agreed (even in only a modest way) with the rest of the Organization of the Petroleum Exporting Countries.

But the world has changed. It's hard to think of any OPEC member state, except perhaps Kuwait, in a position to accept a sustained cut in production and revenue. The Saudis are on their own. Restoring order would require a serious cut in output of perhaps 2 million barrels per day for a sustained period to rebalance a market in surplus, even in the absence of significant supplies from Libya and Iran.

In the short term, such action would require a rewritten budget, reduced domestic welfare and defense spending and a cut in subsidies to regional allies struggling in the aftermath of the "Arab Spring".

In this fevered setting, the scope for miscalculation is enormous. Oil prices have been set by politics, but fundamentals have a habit of reasserting themselves. Once started, a price fall will be very hard to reverse.

Much of the Saudis' oil market power is psychological. People believe that, because they have controlled prices in the past, they will do so forever. Many investments across the world are grounded on that belief. If it turns out not to be true, investors face an uncomfortable awakening.

The author is a visiting professor at and chair of the Kings Policy Institute, Kings College London.

The Globalist