By John Richardson
THE CONVENTIONAL view is that Saudi Arabia has launched its market-share campaign in oil markets in order to pretty much get rid of the US shale-oil industry.
By so doing, it would secure its long-term economic future through driving global prices back up to the region of $100 a barrel, goes this argument. And by getting rid of US shale oil, Saudi Arabia would once again become a crucial supplier of crude to the US. This would guarantee that the Kingdom would remain of huge geopolitical importance to the Americans.
Because this accepted thinking is so firmly entrenched, the assumption is that the falling costs of shale oil,and so resilient US production, mean that Saudi Arabia has got it very badly wrong. For example, in this article, the UK’s Daily Telegraph argues the following:
If the aim was to choke the US shale industry, the Saudis have misjudged badly, just as they misjudged the growing shale threat at every stage for eight years. “It is becoming apparent that non-OPEC producers are not as responsive to low oil prices as had been thought, at least in the short-run,” said the Saudi central bank in its latest stability report.
One Saudi expert was blunter. “The policy hasn’t worked and it will never work,” he said.
The evidence that the Daily Telegraph used to support this argument is that shale-oil costs continue to tumble as producers move up the experience curve:
Smart drill-bits with computer chips can seek out cracks in the rock. New dissolvable plugs promise to save $300,000 a well. “We’ve driven down drilling costs by 50%, and we can see another 30% ahead,” said John Hess, head of the Hess Corporation.
The Daily Telegraph goes on to make the point that the Baker Hughes measure of the number of rigs in operation no longer tells the real story, as it is the efficiency of the rigs that are running which today matters more than the actual number.
If you adhere to this argument there is another reason to believe that the Saudis have got it very badly wrong for the rest of 2015 least. This is the hedging activity carried out by the US shale-oil industry. Because they have hedged oil in the futures markets at $90 a barrel in the second half of this year (so much for any chance this actually happening!), they will be able to sell physical supplies at much, much lower prices and still make a profit.
You can take this argument further by claiming that despite WTI oil futures being at just $51.88 a barrel for December 2016, this does not necessarily mean that by then the shale-oil industry will have sharply cut back on production. Sure, the producers may be unable to take out more attractive hedges to protect themselves against weak physical prices, and so some of the smaller operators might as a result run out of cash. But this blog post from the oilprice.com supports an argument I made last October:
Even as US shale hedges are about to expire, some of the imminent bankruptcies would not result in wells getting abandoned, it would only result in cheaper acquisitions of bankrupt companies by their much bigger competitors [or by private equity companies, as I again discussed last October]. Once oil prices again rise to $60 per barrel levels, the bigger oil companies would naturally ramp up their production levels which would in turn increase US crude-oil production.
The other argument you can make is that because the technology is already out there, fracking could one day be economically transferred overseas, even if the US shale-oil industry heads into the sunset. China offers a lot of as it has the world’s largest shale-gas reserves – and so seems likely to have lots of shale oil as well.
Reasonable people can disagree, and so I disagree with the arguments that Saudi Arabia has ever imagined that it could get rid of US shale oil. Here are my reasons why:
- They have understood for a very long time that the flexibility of the fracking process has created the world’s new No1 “swing” producer. Why on earth quit altogether when a.) As I said, shale-oil costs are coming down and b.) There is always the chance that tomorrow oil prices pick up a little and, bang, you are back in profit? Shale oil wells can be turned on and off again in a matter of weeks in response to a change in markets.
- And they have long realised that once you invent a technology, it it isn’t going to disappear. So close down the US industry and you might still end up with a low-cost competitor somewhere else, perhaps even in China with huge government back.
- And talking about geopolitics, even if you could achieve the impossible of destroying a US industry that has created hundreds of thousands of jobs, this is hardly going to win you many friends in either the White House or Congress. In the process, you might instead even end up losing some friends.
So I think that the Saudis pumping more oil as prices fall is more likely about these two things:
- Getting rid of future Canadian tar, or oil, sands projects. Unlike shale, upfront capital costs here are huge, and so it is these investments that have slowed-down as a result of falling oil prices. So have conventional oil-field investments – again because the upfront costs are big.
- Crucially, also, I think that Saudi Arabia realises that the climate-change debate is essentially over. Governments and most of the world’s population now accept that human activity is responsible for rising global temperatures. As we move away from oil as a fuel, perhaps more rapidly than many people think, Saudi Arabia faces this choice: Either pump hard now whilst we can, otherwise we will end up being forced to leave our most-valuable national resource in the ground – for good.
Where Saudi Arabia has travelled other oil producers will surely well follow. Why cut production when there is no chance of a big oil-price recovery, given that consumption is slowing down? All you would end up doing would be to lose market share.
I also feel that because the world economy is now entering the New Normal, producers everywhere will come to recognise that $100 crude was only ever a fabrication of financial markets. It was never really affordable between 2009 and 2014, and only got there because government stimulus gave speculators the motive to spin a wholly false story about real supply and demand.
Now that stimulus is being withdrawn, we are left with the oil price that individuals and oil-importing countries can really afford, which is an awful lot less than $100 a barrel. Why shouldn’t that long-term average price be around $30 a barrel?