The Crafty Saudis: How They’re Sustaining Low Oil Prices
The oil market continues to be oversupplied and barrel prices remain low. It’s mostly the Saudis’ doing, and its part of their strategy to replace OPEC with a new Global Corporate Oil Board. Their newest tactic is a boost in domestic refining and growth in their refined product exports. Where does everyone else stand, and where will this go?
In what seems to be becoming an on-going series on Policies of Scale, I’m writing again about Saudi Arabia’s long game strategy in maintaining its dominance over the global oil market. Part 1 explored the Kingdom’s overall strategy of creating a new “Global Corporate Oil Board” to replace the antiquated OPEC, and Part 2 gave an update on their progress. This piece focuses on a new tactic in the Saudi strategy: shifting some crude from export to refineries. This especially shrewd development is helping keep the Royal Family out front of market developments and in control of the emerging Global Corporate Oil Board.
I wrote Part 1 four months ago when people were surprised that the Saudis were leading the effort to create a global glut of oil despite their reliance on oil revenues to secure their state, fund the country’s “private” economy, and wage proxy wars in Syria and Yemen. Four months later, the market is still oversupplied, Saudi production is at the same levels and crude oil has wavered upwards from about $45 then to only $10 higher today (still well below the country’s fiscal break-even price).
Two months ago I wrote Part 2, and while conditions hadn’t changed – there was still a glut, prices remained low, the Saudis continued pumping oil and fighting in Syria and Yemen, and the domestic economy hadn’t liberalized or diversified – the Saudis hadn’t changed a thing on their end. The only thing that changed was the American oil industry’s ability to sustain low prices through greater efficiencies.
Today, well, these conditions still persist. As I explained in Part 1, the Saudi strategy was to accept that OPEC would never be able to manage the market like it once had and therefore replace it with a new global corporate board that it could manipulate. This time the board would have to include liberal states whose governments did not control domestic production (namely America, but also Canada) as well as countries with state-run industries that didn’t care about anyone but themselves and so wouldn’t likely volunteer to cut production to sustain a global price target because of how reliant they are on the revenue (namely Russia). In order to be able to steer these countries’ oil production, then, the Saudis would have to beat them into submission the free market way: use the Kingdom’s unique swing production capacity to force changes in private market company decision-making in the United States and pin Putin up against the fiscal margins.
The risk with that strategy was the Kingdom’s own revenue needs. For just how long can the country sustain remarkably sub-fiscal break-even prices? No one outside a small group of Saudis knows. Their response now is quite interesting and ingenious. They’re cutting crude exports in favor of ramping up domestic refining capacity to export refined products. First they established dominance through sheer volume, and now they’re extending their influence into an area where they can capture new profits through a value-added service they hadn’t really been leveraging.
One thing that has changed since I wrote my last piece is the Iranian nuclear deal. Many people have downplayed how quickly and significantly Iran can add new production to the market, and just how much new Iranian oil an oversupplied market could accommodate. The consensus has been that Iran would need at least a year to add the 1 million new barrels per day that Iran’s oil minister has been promising.
However, a new IAEA report questions the common wisdom by pointing to how wrong similarly pessimistic predictions were of Libya after its civil war and Venezuela after a crippling employee strike at the state-owned Petroleos de Venezuela SA.
The Libyan civil war that ended in Muammar Qaddafi’s capture and execution caused chaos in that country that all but halted production with analysts, traders and even Libyan rebels predicting output wouldn’t get back up to 1 million barrels per day for 18 months. The reality: it took only 6 months. The strike in Venezuela caused massive damage to equipment and led to the firing of thousands of workers. Still, production spun up to 2 million barrels per day in just four months.
The Saudis aren’t dumb, and I doubt they are expecting Iran to take a year to add those 1 million barrels to their daily production, especially the way foreign governments and companies are foaming at the mouth to get back into Iran as soon as the sanctions are lifted, if not before.
The Saudis also see what’s going on in the United States. Sure, the Saudis are still pumping at historic rates and the barrel price remains depressed on oversupply. But there appears to be a major session of M&A in the U.S. shale industry on the horizon. Major integrated giants like Exxon Mobile and Total have about $150 billion ready to spend on gobbling up small and medium-sized shale companies who have continued to produce while struggling to make a profit and retain their overhead, plus another $325 billion that they can shift from planned capital spending to M&A.
According to a new Goldman Sachs report (“Global Energy: M&A”), which is where the data in the previous paragraph originates, majors control “only 5% of the total U.S. shale oil reserves…despite it being the biggest area of supply growth and productivity improvements on a global basis.” This underexposure to the U.S. market, Goldman wagers, was purposeful and they expect the M&A process to pick up in the Fall and focus on shale exploration and production companies with healthy balance sheets and assets.
So with Iran threatening to come back online in a big way and a major round of industry consolidation threatening to make American production more financially sustainable, the Saudis have decided to diversify their petroleum product line. Their crude exports fell to the lowest levels in five months in May, but production remained at near-record highs. What gives? Well, they’ve boosted domestic refining capacity to the point that they’re now offering millions of barrels of refined petroleum products. Saudi Arabia is now virtually tied with Royal Dutch Shell as the world’s forth-largest refiner.
The decision to shift some crude from export to refinery also helped keep the crude barrel price low, which continues to reinforce the Kingdom’s strategy of putting pressure on America, Russia and a few other competitors for that matter (like Brazil). It also helped limit the success of Mexico’s first bid round since the country decided to open its oil sector to international oil companies. In what is widely considered a major disappoint, if not a bust, only two of the 14 exploration blocks available at the auction last week were awarded. Expectation was that 4 to 7 of the blocks would go. Now, there are more rounds on the schedule, and the blocks offered in the first round were some of the least desirable. There’s also no doubt that the terms offered last week, which were still largely based on terms decided a year ago when a barrel of crude was $100, were the major headwind against more bidding. However, don’t be surprised if when the good stuff comes up for auction Mexico doesn’t find more bidders, especially if they revamp their terms to provide more incentive.
American oil continues to be lean and may get leaner through M&A, Russia somehow manages to keep pumping (I’m just waiting for the train wreck, though), Iran could come back quicker than expected, and Mexico continues to hold strong appeal and offer the potential of more production. Nevertheless, the Saudis have found a way to respond through an avenue to more revenue that continues to help limit the profits of its competitors. Swing production is a powerful tool and the Kingdom is still using it to build the new Global Corporate Oil Board.