Who Is Saudi Arabia Really Targeting In Its Price War?

By Art Berman, Oilprice.com:

Saudi Arabia is not trying to crush U.S. shale plays. Its oil-price war is with the investment banks and the stupid money they directed to fund the plays. It is also with the zero-interest rate economic conditions that made this possible.

Saudi Arabia intends to keep oil prices low for as long as possible. Its oil production increased to 10.3 million barrels per day in March 2015. That is 700,000 barrels per day more than in December 2014 and the highest level since the Joint Organizations Data Initiative began compiling production data in 2002 (Figure 1 below). And Saudi Arabia’s rig count has never been higher.

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Figure 1. Saudi Arabian crude oil production and Brent crude oil price in 2015 U.S. dollars. Source: U.S. Bureau of Labor Statistics, EIA and Labyrinth Consulting Services, Inc.

Market share is an important part of the motive but Saudi Minister of Petroleum and Mineral Resources Ali al-Naimi recently emphasized that “The challenge is to restore the supply-demand balance and reach price stability.” Saudi Arabia’s need for market share and long-term demand is best met with a growing global economy and lower oil prices.

That means ending the over-production from tight oil and other expensive plays (oil sands and ultra-deep water) and reviving global demand by keeping oil prices low for some extended period of time. Demand has been weak since the run-up in debt and oil prices that culminated in the Financial Collapse of 2008 (Figure 2 below).

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Figure 2. World liquids demand (consumption) as a percent of supply (production) and WTI crude oil price adjusted using the consumer price index (CPI) to real February 2015 U.S. dollars, 2003-2015. Source: EIA, U.S. Bureau of Labor Statistics, and Labyrinth Consulting Services, Inc.

Since 2008, the U.S. Federal Reserve Board and the central banks of other countries have further increased debt, devalued their currencies and kept interest rates at the lowest sustained levels ever (Figure 3 below). These measures have not resulted in economic recovery and have helped produce the highest sustained oil prices in history. They also led to investments that are not particularly productive but promise higher yields that can be found otherwise in a zero-interest rate world.

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Figure 3. U.S. Federal Funds rates and WTI oil prices in January 2015 U.S. dollars. Source: U.S. Bureau of Labor Statistics, EIA and Labyrinth Consulting Services, Inc.

The quest for yield led investment banks to direct capital to U.S. E&P companies to fund tight oil plays. Capital flowed in unprecedented volumes with no performance expectation other than payment of the coupon attached to that investment.
This is stupid money. These capital providers are indifferent to the fundamentals of the companies they invest in or in the profitability of the plays. All that matters is yield.

The financial performance of most companies involved in tight oil plays has been characterized by chronic negative cash flow and ever-increasing debt. The following table summarizes year-end 2014 financial data for representative tight oil-weighted E&P companies.

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Table 1. Summary of 2014-year end financial data for tight oil-weighted U.S. E&P companies. Money values in millions of U.S. dollars. FCF=free cash flow (cash from operations plus capital expenditures); CF=cash flow; CE=capital expenditures. Source: Google Finance and Labyrinth Consulting Services, Inc.

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Table 2. Summary table of cash from operations and capital expenditures for tight oil-weighted U.S. E&P companies. Values in millions of U.S. dollars. Source: Google Finance and Labyrinth Consulting Services, Inc.

Some rationalize the negative free cash flow as an expansion of capital base that will result in future profits. The following table shows that over the past 4 years, tight oil negative cash flow increased and has reached a cumulative of more than -$21 billion for the representative companies. Almost half of that negative cash flow took place in 2014.

The average U.S. oil price from January 2011 through year-end 2014 was $95 per barrel. First quarter 2015 performance at $48.50 WTI will be a disaster that makes the previous 4 years look good.

How long do the losses continue before the cheerleaders of shale plays admit that the enterprise is not profitable? Only the more diversified integrated companies like ConocoPhillips, Marathon, and OXY show meaningful long-term positive cash flow. If companies could not show positive cash flow at $95 per barrel, what price is necessary and what will that do to the world economy?

Some of my readers dispute the poor economics of these plays based on incorrect notions of break-even profitability–some believe that tight oil plays are profitable at $35 per barrel oil prices (see comments from my last post).

Following are two slides taken from Schlumberger CEO Paal Kibsgaard’s recent presentation at the Scotia Howard Weil 2015 Energy Conference held in New Orleans. These slides present a well-informed and objective view of how tight oil plays compare to other plays.

In my Figure 4, Mr. Kibsgaard shows that the average break-even price for tight oil plays is about $75 per barrel. By comparison, Middle East OPEC break-even prices are less than $10 per barrel. Other conventional oil plays break even at less than $20 per barrel.

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Figure 4. Slide from Schlumberger CEO Paal Kibsgaard’s presentation at the Scotia Howard Weil 2015 Energy Conference.

In my Figure 5, Mr. Kibsgaard shows Schlumberger’s assessment of drilling intensity or efficiency. For nearly equal oil-production volumes of about 11 million barrels per day, U.S. oil producers drilled more than 35,000 wells and 297 million feet of hole compared to 399 wells and 3 million feet of hole for Saudi Arabia.

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Figure 5. Slide from Schlumberger CEO Paal Kibsgaard’s presentation at the Scotia Howard Weil 2015 Energy Conference.

U.S. companies drilled almost 100 times more wells to reach the same daily production as Saudi Aramco. Strident claims of increased efficiency by tight oil producers sound absurd in this context.

Prolonged low oil prices will prove that tight oil plays need at least $75 per barrel to break even. When oil prices recover to that level, only the best parts of the tight oil core areas will be competitive in the global market. As production declines from expensive tight oil, oil sand and ultra-deep-water plays, inexpensive Saudi oil will gain market share.

Saudi Arabia is not trying to crush tight oil plays, just the stupid money that funded the over-production of tight oil. Too much supply combined with weak demand created the present oil-price collapse. Saudi Arabia hopes to prolong low prices to benefit their long-term needs for market share and higher demand. By Art Berman, Oilprice.com

In the US, energy companies are “biding their time in the hopes they don’t have to face the music.” Read… The Chilling Thing Blackstone Said about the Oil Bust

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  7 comments for “Who Is Saudi Arabia Really Targeting In Its Price War?

  1. yes!!
    Apr 20, 2015 at 10:57 pm

    couldn’t be more spot on! US industry going in the dumper for a few years at least…

  2. Night-train
    Apr 21, 2015 at 3:25 am

    Absolutely spot on! Anyone who has been involved with E&P knows that booms alway result in wells that never should have been drilled, being drilled. The shale oil plays are that—- on steroids. I have never seen so many unrealistic promises made concerning any oil play. Many people with whom I discussed my concerns reacted like I had insulted their religion. I began to think I had slipped into Superman’s Bizzaro World. Thanks for the dose of sanity.

  3. NY Geezer
    Apr 21, 2015 at 8:13 am

    The implication here is that Saudi is strong enough fiscally and economically to be able to use its oil weapon to target and destroy adversaries. I doubt that this is correct.

    In my view Saudi’s situation is precarious. Now it is fighting for survival, not domination. The other parties in the struggle are also fighting to survive. No party is dominant today. That is why they are fighting for market share. To emerge from this each party must seek to destroy its opponents’ ability and will to compete. Under this scenario the struggle for oil dominance will become much more vicious and destructive.

    Of course it is possible that the competing parties will declare a truce and compromise their interests.

  4. Jason Pend
    Apr 21, 2015 at 10:32 am

    This is total baloney by Schlumberger CEO. Well, not total baloney, but incorrect. Much of current Saudi oil production is based on existing fields. A correct comparision would only take into account the increase in production since their current drilling program went into implementation, probably since 2010 would be my guess. CEO is either stupid or playing some kind of game.

    • Apr 21, 2015 at 12:16 pm

      But wait… you shot from the hip before doing the math.

      Fracking has steep decline rates. So if in a particular play, an oil company drills 10 wells which all start producing in January, production will decline sharply over the next two years – let’s say by 80% (every play is different, but it’s representative and an easy number to do math with). So just to MAINTAIN production, over those two years, the oil company will have to drill 8 MORE wells. At the end of year two, it will have drilled a total of 18 wells. But now the new wells have the same decline rates, and the company will have to drill even more wells just to maintain production at a flat level. Etc. etc.

      Multiply that by thousands of wells across the country.

      That’s the treadmill of fracking. And that’s where the big numbers come from. The math is very different in conventional wells where decline rates stretch out over many years, and even decades.

      The folks at Schlumberger know what they’re talking about. And when you shot from the hip, you didn’t hit them. Did you check your foot to see if it’s bleeding?

      • Jason Pend
        Apr 21, 2015 at 10:26 pm

        You may be right about the shale treadmill, but I still don’t think it’s a fair comparison. Probably a better comparison would show that Saudi is on a treadmill of their own. After all, their major fields are in decline; that much is certain.

        • Night-train
          Apr 22, 2015 at 2:57 am

          I have heard the Saudi decline narrative for years and some day it will be true. Not really sure if that day is here. I do know that Wolf is right about the shale plays “Red Queen” conundrum. And Geologically, there is little comparison regarding the quality and behavior of the Saudi conventional reservoirs and what I consider to be the pseudo-reservoirs found in the shale patch. Also, at the end of the day, an oil well is only successful if it is economical at current oil prices. We used to have the concept in the industry of “a geologic success and an economic failure”. Too many of those would lead to the reality of “Job failure” followed by unemployment.

          I still believe that the oil plays in the vast majority of shale prospects are only viable with prices north of $80/bbl. And that price gets higher drilling away from the fairway.

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