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The US And China: Saudi Arabia’s Big Picture Oil Strategy

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By John Richardson on 16-Sep-2016


By John Richardson

THE above chart should tell you a great deal of what you need to know about Saudi Aramco’s interest in buying the LyondellBasell Industries (LBI) refinery that’s located in the Houston Ship Canal in the US:

  • Between January 2007 and October of this year, the  Eagle Ford shale-oil field in Texas will have seen the efficiency of oil output from reach of its rigs increase by 2,700%
  • The Bakken field in North Dakota is meanwhile set to see its oil output per rig jump by 730%.
  • The Permian basin, which is again in Texas, will see a 710% improvement with the Permian Basin offering a lot of potential for further innovation.

These efficiency improvements have of course dramatically reduced production costs. For example, US shale oil company Pioneer Natural Resources reduced its Q2  2016 production costs to just $2.25/bbl – $12.25/bbl.

And any sensible analysis of the macroeconomic trends will tell you that this innovation will go on and on and on, as the US shale oil industry is a vital for source of growth for the US economy.

Aramco – and with it of course the Saudi Arabian government that owns Aramco – has been very well  aware of all these dynamics for several years now. So it just doesn’t add up to suggest that the Saudi market share strategy in oil markets has ever been about driving the US shale oil industry out of business, as the Kingdom has long understood that this is impossible.


Winning the New Volume Game

The strategy is instead a recognition that we are in a world where oil will remain very, very cheap compared with its recent history. If we can get rid of our tendency to anchor our analysis in to only studying recent price history, we will get closer to good oil-price forecasting. Why not $26/bbl as a future long term average price?

The LBI purchase would help Aramco secure volumes in these three ways:

  1. The US is now importing only 1.3m bbl/day of Saudi crude compared with $1.8bn in 2003, and securing this refinery will help to partially reverse this trend.
  2. The LBI refinery is capable of processing heavy, sour crude. Aramco is unable to sell its heavy sour crude to many refineries in Europe and Asia because they are only configured to handle light, sweet grades of oil.
  3. Aramco would increase its Gulf Coast refining capacity by 50%, and in so doing of course gain a bigger share in local gasoline, diesel and kerosene etc. markets.

The LBI deal would also help Aramco execute Saudi Arabia’s Vision 2030. Vision 2030, which was announced in April, involves adding more value downstream of oil through additional investments in both refining and petrochemicals.

Politics, though might get in the way of Aramco acquiring LBI’s Houston refinery. 


Vision 2030 and One Belt, One Road

But Aramco is of course not just focusing on the US as it tries to fulfil these national strategic objectives. It has already invested in refinery capacity in Europe, Indonesia and Japan – and it operates a joint venture refining and petrochemicals complex in Fujian province in China.

China is particularly important for Saudi Arabia because China’s oil demand is expected to grow from 6m/bbl today to 13m bbl/day by 2035.

And from the perspective of China it needs Saudi crude because, unlike the US, there is no realistic prospect of it becoming energy independent.

There is another important mutual interest: Saudi Arabia’s Vision 2030 strategy and China’s One Belt, One Road initiative are both centred on creating new job opportunities.

Whilst pointing out that tactically these two programmes are different, in an article on its website Aramco writes that “they are similar in that they both put forward transformative yet achievable initiatives that capitalise on areas of national strength for the benefit of their populations”.

Aramco adds that 160 Chinese companies are already working in Saudi Arabia, including Sinopec at the Aramco/Sinopec joint venture Yasreef refinery in Yanbu.

“Vision 2030, coupled with the One Belt, One Road initiative, presents new opportunities for China and Saudi Arabia to go beyond the current level of collaboration and partnership and contribute even more to the development of the two countries,” says Aramco.

As for further Saudi investments in China, in January Aramco disclosed that it was in discussion with CNPC and Sinopec to build refineries in China.

And at the end of August, Aramco chairman Khalid al-Falih said that talks with CNPC for a refinery in Yunnan province were at an advanced stage, and that “we hope to reach an agreement this year”.

All of this is a further reminder that in the New Normal world, any good analyst needs to spend most of her or his time focusing on the political and social issues.