“If I reduce, what happens to my market share? The price will go up, and the Russians, the Brazilians, U.S. shale oil producers will take my share.”
That quote is from Saudi Oil Minister Ali Al-Naimi. And it's the official justification for why Saudi Arabia won't cut its oil production to be more in line with current demand.
Heck, Saudi Arabia has been cutting deals with China and others to sell its oil at below market prices!
That will certainly help the country get market share. It will also keep the pressure on prices.
The Saudi decision to keep pumping even though the global market is oversupplied by as much as 2 million barrels a day will cost it around $39 billion. Bloomberg reports that's what the Saudi budget deficit will be this year.
Last year, the Saudi budget deficit was around $12 billion, even though oil prices were high.
Of course, when you have $732 billion in reserves like the Saudis do, a little deficit spending is no big deal — especially when the payout down the road will be so huge...
To the Victor Go the Spoils
Market share isn't the only thing going on here. Companies routinely lower prices in order to take market share and crush weaker competitors. And once you have a controlling market share, you can run prices back up and make out like a bandit...
This is what the Saudis are doing right now: They have driven oil prices lower, they are taking market share, and there will be higher prices down the road.
Saudi Arabia won't even have to lift a finger to get oil prices higher — the market will take care of that for it. The Saudis will be able to sit back and rake in the cash.
Big changes in oil supply cannot happen quickly, especially in countries where oil supply is controlled by independent companies, like here in the United States.
Imagine the U.S. government issuing orders that U.S. oil production must be cut by 1 million barrels a day. That wouldn't happen because, for the most part, we let the market forces of supply and demand dictate how much oil companies produce.
But U.S. oil companies have a special problem: debt. They've taken on $550 billion in debt (bonds and loans) since 2010. They have to keep pumping in order to meet debt obligations. CreditSights says default rates on energy junk bonds will double this year.
Small U.S. oil companies (Goodrich Petroleum and Lightstream Resources, for instance) are starting to sell off assets in the Bakken, Eagle Ford, and other oil hot spots.
Companies will also spend less on new production. And that's where the problems will begin...
A Dangerous Game
Continental Resources (NYSE: CLR), the biggest Bakken producer, has cut its 2015 CAPEX spending plans in half, from $5.1 billion to $2.7 billion.
Crescent Point (NYSE: CPG), Canada's third-largest producer, cut its spending plans by 28%.
ConocoPhillips (NYSE: COP) is cutting spending by 20%.
U.S. oil company CAPEX spending will likely be down over 30% in 2015, with onshore drilling activity down 40%. Globally, oil sector spending will be down 10% to 15%. And as much as $150 billion in new oil projects will sit idle.
Now, here's the thing: It takes time to develop new oil fields. And in the meantime, existing oil fields are in decline.
In 15 years, half of current oil production will be completely depleted. That means over the next 15 years, the world has to develop around 50 million barrels of oil a day just to maintain current production numbers.
It's going to be hard to support that development if oil companies are cutting spending.
It took the U.S. six years to add 5 million barrels a day in oil production.
Global oil production, meanwhile, hasn't really grown much in 10 years. What growth there has been is easily attributable to U.S. shale production...
As this chart shows you, without the increase in U.S. production, global oil production would have gone into decline three years ago. And this is why I say the Saudis are devious bastards: By refusing to cut production and forcing a collapse in pricing, they are forcing oil companies to stop developing new oil fields.
In other words, they are setting up the conditions for a perpetually under-supplied oil market.
That, in turn, will cause a massive spike in prices, like what we saw in 2008.
Right now, the world is oversupplied by 1 to 2 million barrels of oil. Interestingly enough, about a year ago, both the EIA and the IMF thought demand was going to rise that much by now. It hasn't, and it's largely because Europe's economy is a disaster and China has slowed more than expected.
In fact, global oil demand has been pretty steady since 2012, moving within a 2 million-barrel-a-day band...
Eventually, the global economy will improve, and oil demand will increase. The Saudis know that when this happens, oil prices will launch.
I expect they are happy to run budget deficits as long as it takes — because the payoff for them will be huge.
Until next time,
Briton Ryle
Jason Lim
I don't think the Saudis are wrong or are bastards, anyone in their situation will probably do the same thing to protect themselves in the long run. It's called business strategy.
2015-02-18 13:15