Saudi Arabia Declares Cease-Fire in Oil War
The new Saudi oil minister, Khalid Al-Falih, says the oil glut is over. That means the kingdom's war against U.S. shale producers is coming to an end, too. Who won it is a tough question to answer; on balance, it's probably the Saudis, but they have paid a huge price, and the surviving U.S. frackers have also benefited.
In September 2014, Saudi Aramco, the kingdom's state oil company, simultaneously increased output and discounts to Asian customers, making it difficult for producers with higher costs to compete. The U.S. shale industry responded with desperate bravado, cutting costs, perfecting technologies and pumping like crazy to avoid defaulting on its debts. Yet, according to Haynes and Boone's Oil Patch Bankruptcy Monitor, 81 North American oil and gas companies have filed for bankruptcy since the beginning of 2015. In Texas alone, there have been 41 bankruptcies, representing $24.3 billion in debt.
As a result, U.S. oil production has declined to late 2014 levels, while Saudi Arabia has defended and indeed increased its market share. Last year. it maintained its export volume to the U.S., while sales to China grew by 4.5 percent and to India by 18 percent.
The North American shale industry knows now that it's at the mercy of Saudi Arabia. The kingdom has more than two million barrels a day -- perhaps even three million if necessary -- of spare production capacity that it can use to flood the market again, drive down prices and render any ambitious American plans useless.
Al-Falih takes a long-term view and expects the oil market to grow, not decline, in absolute terms in the next two decades, despite adverse changes in the energy mix. "Even if the share of oil goes down from, say, 30 to 25 percent, 25 percent of a much bigger global demand means a much higher absolute number of barrels that will be in demand by 2030 or 2040," he told The Houston Chronicle. So it makes more sense to fight for long-term market share rather than a momentarily high price. In that regard, the Saudis have won the oil war.
The repercussions and costs of this victory, however, are harsh. The monetary loss is the most obvious one: At its current output level of 10.2 million barrels a day, Saudi Aramco is making $600 million a day less than if the oil price had stayed above $100 a barrel. The U.S. shale business is missing out on about as much revenue, considering it has lost 1 million barrels a day of production compared with its peak, but the U.S. economy has, on balance, benefited from lower oil prices, while the Saudi one has suffered because it's almost entirely oil-dependent. This is prompting the big policy rethink in Riyad. As Al-Falih, an ally of reform architect Prince Mohammed bin Salman, said in the Houston Chronicle interview, "nobody has the intention of turning off the oil economy in Saudi Arabia. We're trying to build it up. But what we hope while we're doing this is the non-oil economy will grow even faster."
The Saudi victory is also hollower than it might be because some of the kingdom's competitors did not retreat -- on the contrary, they, too, boosted production. While private U.S. companies responded as expected to overwhelming market pressure -- they consolidated, worked on costs, cut investments or went belly up -- the Saudis' major competitor, Russia, redoubled efforts to pump as much oil as it could, because most of the production is concentrated in government hands and the government needed the revenue. Also, Iran, Saudi Arabia's perennial rival, got a free ride after international sanctions against it were lifted. With production costs not much higher than those for the Saudis, it ratcheted up production quickly, filling in for output drops elsewhere caused by the Saudi policy.
Saudi Arabia can live with these results of its war. The current price level of about $50 a barrel is acceptable, and Al-Falih admits that attempts to target specific price levels by regulating output have failed in the past. Russia and the surviving U.S. shale producers are not at death's door at this price point, either: The former's economic decline will probably end this year, and the latter can start making cautious plans for the future rather than fighting for survival.
The equilibrium is fragile: the market's rebalancing has been accelerated by unexpected disruptions that won't be permanent. So Al-Falih is signaling that his country won't tip the scale by increasing production. According to him, Saudi Arabia would like to "maintain that balance while also giving heed to moderate prices for producers and consumers."
Any number of accidents could disrupt this attempt to stabilize the oil price at the current level. Yet Saudi Arabia's willingness to accept $50 as the new normal should reduce volatility, making the market more boring for speculators but friendlier to oil producers and consumers.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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