Saudi Arabia, glutted oil market spawn price war
Kingdom does not want to bear cost of being ‘swing producer’
The free-fall in crude oil prices since a recent peak of $115 Brent last June, when ISIS fighters seized the Iraqi city of Mosul, has been the most spectacular event of 2014 in global energy markets. Since West Texas crude fell below $85, US gasoline prices fell below the psychologically-important $3 a gallon. Since consumer spending is almost 70 per cent of American GDP, the fall in gasoline prices is a de facto tax cut and a stimulant for US consumer spending.
Saudi Arabia’s oil policy will play a dominant role in the next twist in the crude oil market. — AFP
The fall in crude oil prices is largely due to the successful shale oil drilling technologies that have enabled the US to challenge Russia and Saudi Arabia as the world’s leading energy producer. Though the shares of shale oil exploration/production companies with drilling average in Texas, North Dakota and the Rocky Mountain states have been devastated on the New York Stock Exchange, the break-even price for shale oil production in the US is estimated in the $60-$64 range.
The most notable feature of the 2014 oil price crash is a failure of Saudi Arabia to defend $100 or even $90 Brent or signal an output cut. In fact, Saudi Arabia increased its output in both August and September as well as cut prices to its Asian buyers, mainly refineries, utilities and oil traders in Japan, China, South Korea, Taiwan, India and Singapore. Saudi Arabia’s decision to reduce posted prices was followed by Kuwait, Iraq, Iran and the UAE.
Without an Opec agreement and output cut, a price war for downstream market share has accelerated the fall in oil prices. The world oil market has learnt the hard way that Saudi Arabia does not want to bear the financial cost of being a “swing producer” when US shale has raised supply and the European recession has hit refinery demand in the North Sea. In a glut, a unilateral output cut only inflicts disproportionate losses on Saudi Arabia.
US economists and oil traders believe it is not in Saudi Arabia’s interest to trigger a price war in crude oil, given its 270 billion barrels of proven reserves and major spike in domestic consumption due to subsidised electricity and air conditioning demand. The only other explanation for Saudi Arabia’s refusal to cut output as the Opec’s swing producer would be to let prices fall enough to slow production growth of shale oil in North America. This is far too speculative a strategy for a kingdom whose primary security relationship is with the United States. Saudi Arabia’s $138 billion social welfare programmes and its foreign policy commitments to its allies in the Middle East means that its budget break-even price has risen from $65 to $95 a barrel. The last thing Saudi Arabia needs is a budget deficit at a time of war and unrest in Iraq, Syria, Yemen, Libya and Bahrain. However, Saudi Arabia has accumulated $700 billion in foreign currency reserves due to high oil prices.
Energy economists estimate that US shale oil and a fall in demand means the global market has at least one to two million barrels of oil a day in surplus in the spot market. Iraq and Iran have increased their exports to China in order to increase market share from Saudi Arabia, the leading crude supplier to the People’s Republic with 1.1 million barrels a day. Even Kuwait has raised its output to nearly three million barrels a day and signed a strategic export deal with China.
Geopolitical risks in the Middle East have fallen since ISIS has not threatened Iraq’s energy infrastructure or oil export terminals in Basra Province and Iran’s nuclear talks with the Western powers have eroded the sanctions regime.
US domestic production has now reached 8.7 million barrels a day, more than 1.2 million barrels a day since 2012. This is the real reason why West Texas crude has collapsed and the glut is so severe that there is a shortage of storage capacity in Galveston and the Louisiana coast. US imports from the Opec have plummeted by more than 50 per cent since 2008-10, the time of the last crude oil price shock after the Wall Street banking crisis. As US imports shrank, Angolan and Nigerian crude oil was dumped in the Asian spot market, adding to the pressure on Brent.
Even though Libya’s government and parliament have fled Tripoli, its oil ports have increased production by 600,000 barrels a day since July. Libyan oil flows reserved due to a pact between rival militias, an inherently unstable situation that could unravel at any time. However, the oil market is not willing to price Libyan supply shock at a time when there is a glut in the North Sea and in West Texas shale oil. The latest Opec market report indicated 400,000 barrels of extra crude in September, led by Saudi Arabia’s 100,000 barrels.
The November meeting in the Opec will be critical to the prospect of stability in the oil market. While Venezuela and Iran have called for output cuts, in Caracas and Tehran simply have no leverage over Saudi Arabia, which produces one-third of the Opec’s output. Europe’s economic recession and Japanese fall in crude oil demand will also pressure prices. High-cost shale exploration in Canada becomes uneconomic below $75 a barrel. From Alaska to the Gulf, Russia to West Africa, the economic and political impact of an oil glut will change the world. Saudi Arabia’s oil policy will play a dominant role in the next twist in the crude oil market.
The writer is a Dubai-based research analyst in energy and GCC economics.
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