The Saudi Oil Price War Backfires

By Gaurav Agnihotri,

Saudi Arabia has long enjoyed the status of being the top crude oil exporter in the world. With record production of 10.564 million barrels per day in June 2015, Saudi Arabia has been one of the major driving forces behind the current oil price slump.

The Saudis have kept their production levels high since last year in order to drive other players (especially U.S. shale drillers) out of business. Equally clear is the fact that this strategy of maintaining the glut and driving out rivals hasn’t worked so far.

Even when we look at the refining sector, we see that the oil kingdom has been following a similar strategy of flooding the markets with refined fuel. The Saudis have already sparked an oil price war with the Asian refiners downstream by offering close to 2.8 million barrels of low sulfur diesel to the European and Asian markets. This has caused Asian refining margins to fall drastically, the effects of which can ironically now be seen on Saudi Arabia itself.

Saudis are now reducing their crude oil price hikes in Asia in order to save their market share

As the refining margins have fallen in Asia, refiners there have been compelled to cut their refining outputs. This could eventually result in refiners cutting their crude oil imports.

Asia has been one of the biggest cash cows for Saudi Arabia and there have already been some cuts in some of the most crucial markets. India, which was earlier importing most of its crude oil from Saudi Arabia, is now changing its strategy and buying more crude oil from Nigeria, Iraq, Mexico and Venezuela.

This made the Saudis blink and they started offering discounts on its medium and heavy grade crude oil to Asian customers. And, in a latest development, the Saudis are now trying to defend their market share as they have only marginally increased the price of the crude oil they sell to Asia, contrary to industry forecasts.

According to a survey by Reuters on 3rd August, Saudi Aramco was looking to hike the official selling prices of its crude oil (all the three grades) by around $1 per barrel from September 2015. However, the Saudis know very well that their selling prices are already high and a further substantial price hike might result in customers moving to other crude oil producers (much like what India did). The result is that the price hike on its medium and heavy grades is less than half of what the analysts expected while the price hikes in its flagship Arab light grade is below earlier predictions. This cautious move suggests that Saudi Arabia is on the defensive, hoping to protect its market share.

Is Saudi Arabia losing the oil price war?

“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. The main impact has been to cut back on developmental drilling of new oil wells, rather than slowing the flow of oil from existing wells. This requires more patience,” said a recent stability report by the Saudi Central Bank.

In short, Saudi Arabia’s policy of keeping production levels abnormally high and driving out U.S. shale producers simply hasn’t worked. Even as U.S. 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. 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 U.S. crude oil production.

Thanks to its generous public spending and a costly war against Yemen, one of the major worries for Saudi Arabia is that it is burning through its foreign reserves at an alarming pace. According to the IMF, Saudi Arabia’s fiscal deficit could rise to around $140 billion by this year end. From all this, it seems that the Saudis are now getting beaten in their own game and have been trapped in the oil price war that they themselves created. By Gaurav Agnihotri,

But it’s been tough for US oil companies. And even tougher for their investors. And it’s far from over. Read… A True Jobs Massacre Spreads in US Oil & Gas

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  28 comments for “The Saudi Oil Price War Backfires

  1. mikey says:

    Greed for market share is so short sided. As a Canadian, this market manipulation of oil is having its intended consequences to our economy all the while we are protecting you from your enemies in the gulf region to protect Opec big wigs. This surely must stop and when so you must then run or fight and we all know how Saudis fight. Play nice in the sandbox girls or you could be buried in it.

  2. michael says:

    I am not so sure that the Saudi’s primary intent was to put other drillers out of business although that sounds great from a conspiracy standpoint. All drillers need to maintain a specific level of activity to generate income to cover their operating costs. The next option is to offer discounts and as the glut becomes critical, the supply will need to be reduced.

    • Smart says:

      They’ve said on multiple occasions the goal was to drive competitors out of business and maintain market share.

      I don’t get why some people think everyone plays nice.

  3. What oil price ‘war’?

    Oil drillers must sell oil or go out of business. In this regard they are no different from gas drillers, who are losing money on volume.

    If the drillers reduce output the first to feel the pinch would be customers who are already reeling from a decade of high fuel prices and stupid monetary policies which have shifted earning power away from them to banks. Cutting oil extraction does not change that at all, shortages do not make customers richer.

    How high are too high? A lot lower than you think.

  4. Barra says:

    I believe the notion that the Saudi Arabia is seeking to knock out shale production is missing the point.
    Russia is now exporting more oil to China than Saudi Arabia and they are trading it in yuan. It is the Russians that the Saudi’s are trying to break and US shale producers are just fodder in a much bigger game of chess. This is why I believe the US government has done nothing to support oil prices. It will wear the consequences as the overriding threat is the Russian China pivot, Russian aggression in Ukraine and the threat that the yuan poses to the. petrodollar.
    In this sense the US and Saudi Arabia are as entwined as they have ever been.

  5. Night-train says:

    I find this article to be looking very hard for a glimmer of something positive from the author’s point of view, then using that thing to reach an otherwise unsupportable conclusion. From the US shale perspective, $60 oil is better than $40 oil, but it is still not profitable. And you still have to account for Iran’s oil coming onto the market and still being able to support $60. I was told by a sizable conventional oil operator in 2010, that all of their projects were good to go at $70 oil. I expect that holds true for a good many of them. What happens with the Saudi’s market share moving forward remains to be seen. But, this isn’t their first rodeo and many who have underestimated them in the past have regretted it. Don’t lose sight of the fact that they have as good or better information as/than anyone in the industry. They have access to some of the best consultants in the industry. So, I think it is a tad early to declare that they are losing at whatever it is they are trying to accomplish, when we don’t even have a consensus on what that thing is.

  6. mick says:

    “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. ”

    Nope, shale just gorged themselves in the debt markets with money they will never pay back. The real losers are the bondholders of shale oil companies.

  7. Nick Kelly says:

    There are two narratives in the Wolf Pack- one is the disaster looming in the shale gas fields, where a 500 billion mountain of debt can’t be kicked down the road- and will probably take a few banks with it;
    The second is that Saudi Arabia has shot itself in the foot, had its policy backfire, only has its self to blame etc.

    They can’t both be right. If the first narrative is true, and it obviously is since it is just data, then Saudi Arabia would seem to be on the right track.
    I like military analogies so here is one: when Arthur (Bomber) Harris took over as head of Britain’s RAF Bomber Command in WWII, he said (before beginning
    the massive campaign that dwarfed Germany’s efforts) :
    “A lot of people say you can’t win a war by bombing. Well, let’s find out”
    But it took three years for the campaign to hit its stride.
    The point: Saudi’s campaign to wreck an entire industry in the richest country in the world is only a year old. (Saudi also targets Canada’s oil sands but we are easy meat and we have seen tens of billions in cancelled projects)
    Of course no one could expect a bank manager who has lent a hundred million or two to refuse the first request for an extension or even another fifty million until
    ‘prices pick up’
    But at some point the bank has to look to its own salvation- and maybe some managers with buddies in the patch have to leave the bank. And maybe the bank has to be taken over.
    But you can’t expect this to happen in a year, especially when, before the China crash we had glimmers of hope and a rally to $60.
    Given the data from this site about the state of the shale industry- Saudi has no reason to be dissatisfied or to change course.
    Second military analogy: if your strategy is attrition- you have to be prepared for pain. Saudi’s calculus is that shale is hurting more than they are and can take less punishment. Or more precisely- that Saudi can take it longer.
    What could upset their conclusion: a decision by the richest country in the world that nat gas is of strategic importance and deserves a floor price.

    • Wolf Richter says:

      Don’t worry. WOLF STREET allows for divergence of thought, as long as it is well-argued, supported by the data, and interesting … on the basis that you can’t slice salami so thin that it has only one side.

      We don’t do ready-made, easy-to-consume, simple answers here. We like to think on our own…

      • Nick Kelly says:

        I Love the variety. It’s funny- economics is the only field (with its own Nobel prizes, although after the LTCM crisis spawned by Nobel laureates, the relatives of Alfred Nobel may want the prize cancelled) where individuals of impeccable credentials and integrity completely disagree.

    • Michael Gorback says:

      On the contrary, it certainly can be true that Saudi was trying to take out some other country’s oil production (Russia, US, Canada, whoever) and that it also blew up in their face.

      Saudi must sell oil at a significant profit. It has no other major source of revenue and that revenue is desperately needed to placate their citizens with lifestyle goodies. As the article cited above points out Saudi is burning through its foreign currency reserves. No foreign currency reserves means no imports of food, medicine, clothing, trucks, jet fighters, or tanks.

      The fracking industry unwind could certainly have dire consequences for the US economy but oil is not the main source of revenue for the US and it’s not fatal. Not so for Saudi and other oil-based economies like Venezuela, Russia or Nigeria.

      • Nick Kelly says:

        Agree with everything except, I guess ‘on the contrary’
        No doubt Saudi is burning through its reserves. But who is closer to end game- US shale or Saudi? Saudi is using its money to stay alive- shale is using borrowed money.
        Absolutely agree that US does not need shale, and the loss of the industry would not be a disaster for the US ( while it might be for Russia) but this is also part of Saudi calculus- you buy our oil- we buy your planes etc. A win- win. Who needs shale? Not you. Not us!
        Saudi can sell oil at a significant profit at $40, it just can’t hand out goodies at that price. It is conceivable that Saudi could tighten its belt- starting with the two thousand or so princes. A crack down on luxury, especially Western imports of champagne and the like could be be sold as a return to the ultra- orthodox brand of Islam that it part of the House of Sauds claim to rule.

        If this is going to be a long game- at this point I don’t see why Saudi should have to fold and cut production.
        But I’d get going on those princes.

        • Survival says:

          During extended periods of drought, African Lungfish will burrow into the ground and remain dormant until more liveable conditions return.

          Similarly, I think that shale drillers, with their very mobile and modular deployment nature, can go bankrupt for the near-term, but as soon as favorable conditions return, those drillers can and will be deployed again.

          Totally agree that Saudi Arabia clearly does not have that luxury of start and stop, their system must keep plowing forward (even at such unfavorable prices) or they will be in deep trouble – given their practical lack of any other productive economy, I would guess that the situation there is much worse than it appears.

  8. Michael Gorback says:

    I think in order to better understand the Saudi position you need to go back to the oil glut of the 80s.

    The high price of oil due to the oil embargo of the 70s caused oil consumers to become more efficient, such as increasing the mpg of cars. At the same time, oil was found in the North Sea and coming to market. Between the increased supply and decreased demand oil prices dropped. The Saudis tried to prop up prices by decreasing production but the other producers didn’t cooperate and kept pumping out oil (just like now, where every OPEC country is cheating).

    Saudi finally capitulated after several years of severe deficits and they started pumping more, which drove the price down even lower. IIRC it hit $10 or maybe less. It crippled them for well over a decade. In the late 90s oil was still below $20.

    I think this time they decided to just cut to the chase and try to drive the competition out of business since cutting production was a disaster for them the last time. Their target is “everybody else”.

    • night-train says:

      Working in exploration in the industry during the 1980s bust, the word was that the Saudis were trying to reassert discipline to the cartel. There certainly was a lot of cheating on quotas by OPEC partners. It certainly blew up the US domestic industry. A generation of scientists and engineers left the industry never to return. Since I am now retired, I watch this current “oil war” with much interest without the desperation. How low will the price go? How long will it remain depressed? How much will exploration for new fields fall? How badly will conventional E&D be hit.

      Also, how long can shale stay viable at prices expected for the next three to five years. I am of the school that shale plays are impractical for several reasons which have been discussed at this site. Another shale question yet to be answered by the industry is that of secondary and tertiary recovery potential. In conventional oil reservoirs, primary recovery of the resource accounts for around 20% of original oil in place, depending on the primary drive of the reservoir. Much of the total oil produced during the life of the field comes from less profitable secondary and tertiary production phases. At this point we do not know if these enhanced recovery techniques will even work in shale reservoirs. And if they do, how well and at what price. To paraphrase a James Taylor lyric, I’m still a skeptic after all these wells.

  9. Colin says:

    Oddly Saudi Arabia would later increase their production. It’s very difficult to determine how big the glut is. If the glut is smaller than many claim(500k bpd is one estimate I’ve read) it makes sense that Saudi Arabia would keep their production. They produce according to demand.

  10. Petunia says:

    The demand for oil is down and the economy is bad, those things are not in dispute. However, many lifestyle and product changes are taking place that will also impact the demand for oil even in a good economy. The future of oil use per capital is trending down.

    In better times I use to go to the mall 2 or 3 times a month. Now I go 2 or 3 times a year. I have transitioned to buying more online and I don’t see that changing even if my situation changes. Moving the merchandise I buy is more energy efficient if it comes directly to my house, rather than it going to the store and then to my house. The energy use trend here is down.

    The move to cocooning was a financial necessity for us, but everybody is staying home and watching Netflix too. Many less trips to the movies and restaurants moves the energy use trend down.

    Buying more energy efficient products on purpose: light bulbs, computers and parts, solar powered devices. Energy use trend down.

    While the price of energy has not dropped for me, I am still using less than a few years ago, and can see the trend continuing.

  11. ewmayer says:

    Interesting numbers re. the Saudi fiscal deficit – some simply math to put it into perspective: At roughly a half-$billion per day, and 10 mbpd oil production, the deficit represents roughly the current gross sale price of all Saudi oil production. Good thing – as the MMTers so like to remind us at every turn – that deficits don’t matter, eh?

    @Nick Kelly: The economics “Nobel” should better be called the “Swedish Central Banker Prize”, since said bank instituted it after Nobel’s death and arrogated his name in order to lend it prestige. I like to call it the Faux-bel prize.

  12. Puritan says:

    What is the author of this article trying to say?

    How does it backfire Saudi Arabia?

    If they cut the oil production, the price could go up, then US Shale oil would start to flow that would again bring down the price.

    Are you saying that Saudis should cut their production, so that we can produce oil and sell it for higher price?

    • Wolf Richter says:

      The author is saying that this price war is costing the Saudis dearly, but that it is not having, at least not yet, the desired effect, namely forcing down shale oil production in the US.

  13. Merlin says:

    The highly leveraged firms have no choice but to drill and produce until buyout, bailout or bankruptcy, whichever comes first. Buyout is still a while off as those with cash to buy are still looking for the bottom which may not be until the end of the year after bank reviews of loans in October timeframe. Bailout would be some sort of help from the federal gov’t and that is not likely under the Current Occupant. So, bankruptcy is the order of the day for the short term.

    Having also been in the industry since the early 1980s, i wish i was retired like NT. :)

    And don’t forget the fracklog if prices do edge up to $60 or so.

    • night-train says:

      Hang in there buddy. Your time will come. Until then, good luck to you.


  14. Voice of Reason says:

    The glut of oil is overwhelming and growing larger with each new tanker floating around the world looking for storage capacity. Prices will have to come down further and this will not bode well for markets globally as energy is a large component of the major markets. And of course the markets are all leveraged and manipulated. If you have not noticed, the elite are sweating as no one knows how this will unfold without a life changing crisis. The world is depending upon the FED to have a plan but Yellin is not piloting this plane. She is flying over the Pacific blind folded trying to read navigation charts from the 1970’s in brail. What could possibly go wrong?

  15. Roland says:

    1. The Saudis can afford to sell oil cheap, albeit they can’t bribe the people as much. But there are a lot of people who will get hit in Saudi Arabia before serious political unrest results. For example, the austerity will probably hit expat Pakistani construction workers’ remittances before any Saudi citizens get it in the neck.

    2. The Americans have an unlimited central bank. There is no credit crisis in the frack sector that their CB can’t inflate its way out of. For the power-political purpose of hitting Russia, the Americans will ride out the frack pain.

    3. A country like Canada gets hurt bad in this game. Their oil is costly to produce, while their central bank is second division in the fiat league. Canada’s first world pretensions will be tested.

  16. ERG says:

    I dont know why there are so many who think SA’s actions have some sort of hidden agenda. They do not. The fact is they have NO CHOICE but to do what they are doing. Please remember that their price drop coincided with the end of QE in the US. You cant support a high price for oil when the currency with which it is traded is taking a break from destroying its own value. You also do not dare pull back on production when, besides terrorism, oil is the ONLY thing you export. SA has to sell oil to live. Period. Doesnt matter what the price may be.

  17. Puritan says:

    I think this oil bust is not going to be like what we saw in the previous busts. It is the beginning of a systemic problem from other technological advancement. This oil bust is just the beginning of the end of the oil industry. You won’t see many of these major oil companies after 10 years that is my predication.

    The Digital camera bankrupted Kodak film, Computer bankrupted Typewriter, Cell phone busted land line phones, Internet bankrupted many businesses such as newspapers, brick and mortar shops, and so many to name. Even USPS is running on tax payers’ money since not many people are buying stamps. Now USPS is making money from junk mails.

    Electric Motors will fold up Internal Combustion Engines. Tesla will market low end electric cars that cost about 35K within two to three years. Their current model, Tesla Model S cost about 100K which has no influence in the oil market as of now. And I expect major car companies would mass produce electric cars within few years even before if there is any chance for the oil price to go up as high as last year unless there is a sudden major war in the World.

    Once the Internal Combustion Engine is replaced by electric motor that could bring down the crude oil price into a single digit, I presume.

    All of the oil Kingdoms know that their oil under the sand would price less than pure drinking water, once electric cars become common. So, they are pumping it as much as they can; as fast as they can and sell it at whatever price they can get now before Electric Motor replaces ICE. That is one of the reasons the Saudi minister said, you would never see a $100 /bbl again.

    • Wolf Richter says:

      One minor quibble: Tesla. Tesla is irrelevant. It might assemble 50,000 vehicles in 2015, out of 75 MILLION or so globally. It’s not even a rounding error. It’s a cool name, and makes a few cars for the wealthy. But here you’re right: electric cars WILL put serious damage on oil demand. ALL automakers will offer them when battery technology advances to where batteries are cheap, carry a bigger charge, weigh less, and can be charged in a reasonable time. When that happens, charging infrastructure will pop out of the ground, and off we go. It all depends on the battery technology. Tesla doesn’t own that technology. Other companies do.

  18. merlin says:

    This link provides a nice pie-chart of the use of petroleum in the US, and has some provocative articles regarding alternate-energy vs fossil fuels.

    This is the Petroleum Age and will continue for many decades to come. There is simply no natural or man-made substitute for petroleum.

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