Has Saudi Arabia Won in the Oil Price War Yet?

Kristian Rouz – Global oil prices have stabilized near $60/bbl during this past week, while the US energy sector took a double blow as the major strike nearly paralyzed the work of crude storages and refineries from California through Texas, and the crude producers have been decommissioning drilling rigs 12 weeks straight already. Allegations have asrisen that the Saudis’ decision taken last November to leave oil production quota in place, allowing for the oil prices’ decline in hopes to wipe the US production off the market has proven right, and that oil price might go up now. However, the US still has the final say in this paradox: while the amount of oil rigs has decreased by 39 percent, the actual production of oil is ever increasing, now standing at the record high of 9.5 mln bbl/day.

The United States counts the amount of active drilling rigs, something almost completely ignored by the market for most of second half of 20th century. The methodology, devised by Baker Hughes Inc. in the year 1944, links crude valuation to the weekly amount of oil pumps in order, and as the US is becoming a large crude producer once again, its old ways are back, possibly suggesting the near replication of the golden age for the US economy it enjoyed in the 1950s. Or maybe not.

Anyways, some three months ago OPEC, led by Saudi Arabia, offered an old solution to the new problem of the US hammering global oil prices. The plan was to increase oil output as much as possible in order to render most US oil producers unprofitable, forcing them to leave the business, leading to oil prices returning to a comfortably high reading of over $100/bbl. And while the plan might seem to be working, at least partially as oil prices stabilized somewhat, there is absolutely no reason to believe oil prices will increase further. The reason is simple – the US is still managing to increase oil production while the amount of active oil rigs is declining.

Last week, there were only 1,019 oil derricks active, and by today the number declined further, to 986 units in order. The US energy sector in also experiencing a decline in investment, which must have impacted supply in a negative way. However, even though the oil business was rocked by a major strike, oil output is on the rise in the US. Why?

The reason is best explained by the nature of shale oil industry. The innovative technologies of fracking and horizontal drilling, among other features, allow for the oil-well derricks to be either de-commissioned or re-commissioned very quickly, in a matter of two-three days. It means that the decline in numbers of oil rigs is not a decline in oil production, but an adjustment strategy. As crude prices drop, US oil producers stop pumping from the least profitable oil wells only to return to them later, when the price is better, instead of abandoning them as one might have thought. That is why oil production in the US is still on the rise – the most profitable and cost-efficient in terms of extracting volumes, labour and logistics oil-well are exploited in a more aggressive way.

“We haven’t really seen an outright chunk of U.S. shale or any other high-cost production falling,” Miswin Mahesh, an analyst at the London-based Barclays plc, said.

All that indicated that the US oil industry is no less tricky than the Saudis. To the underinvestment the American drillers responded with increased intensity of extraction, cutting expenses and ramping up output. It is worth noting that a spread between the oil value in America and in Europe is at its highest in many years, having reached above $10. WTI crude sells at some $49/bbl, while Brent value stands at $60-$62/bbl, depending on type of contract.

According to the data released by the US Energy Information Agency (EIA), in the 3rd week of February America produced some 9.29 mln bbl/day, the record high since 1972. The EIA forecast for 2015 crude production in the US was revised down to 9.3 mln bbl/day from the previous reading of 9.42 mln bbl/day though, but the upward trend is still in place, the EIA added.

On the other hand, most of OPEC nations are already experiencing gruesome fiscal hardships, with aggregated oil revenues falling to $446 bln in 2015 from $703 bln in 2014, which is 37%, coincidentally (or not?) equivalent to the decrease in numbers of active American oil rigs. In OPEC nations, oil production is either controlled or directly undertaken by the government of state, which is why they are so sensitive to the decline in oil prices – it hits their budgets. The US meanwhile might have suffered some commercial losses, but the energy sector in America is not even nearly in crisis, finding its way around with cheaper oil.

Will the Saudis be able to wipe out the US oil production this time before most of OPEC member states go bankrupt? In 1986, America’s oil business was a polypoly-style play of several large producers, proven vulnerable before the mighty international oil cartel. Today, most of the US oil output is generated by small-time enterprises, tenacious and cost-efficient, with advance technology that provides an additional competitive edge. The Saudis have consciously attempted to repeat the scenario of the 1986 ‘oil bust’ with America, but they have far underestimated their new-old rival.

But, but all the conspiracy theories aside, the Saudis, similar to most of the world’s oil producers, might be struggling to retain their share of global oil market by increasing output maximum capacity. With American oil coming on strong, a cut in production by other market participants would not stop the prices from falling, resulting only in their loss of traditional consumers to the US.

There is no winners on the production side of the global oil business, as even the booming American energy sector is facing major turbulence, prompting President Obama to veto the Keystone XL for a while (an advent of Canadian oil would send the oil prices below any intelligible breakeven).

The winners are on the consumption side – the automobile owners, the chemical industry and pharmaceuticals, utilities and many other sectors. Cheaper oil is a blessing allowing a major spurt in the world’s development, so there’s no time to mourn the oil-addicted, authoritarian, often unpredictable and sometimes openly hostile petrocracies.

Another cycle of industrial development is starting, and is promising amazing prospects of global prosperity.