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Saudi Arabia Surrenders To U.S. Shale

Chesapeake drilling tower

“Ending wars is very simple if you surrender.” – PJ O’Rourke

The new OPEC deal to cut oil output – the cartel’s first since 2008 – amounts to nothing less than Saudi Arabia’s surrender to the power of American shale.

It has come about due to Riyadh’s belated, horrified understanding that it has utterly lost control over the energy market, running through its capital reserves in the process. Rather than young, feckless Deputy Crown Prince Mohammed bin Salman using Saudi Arabia’s John D Rockefeller strategy to permanently drive U.S. shale out of the energy market, the exact opposite result has occurred. Unwittingly, the Saudis have made the Americans the new global energy swing producer, the permanent ceiling for the global price of oil.

This, in its way, is as momentous a shift in global power as the stunning recent Brexit and Donald Trump votes. Whereas Brexit showed Europe to be in absolute decline, while the election of Trump brings to an abrupt end 70 years of the U.S. as the global ordering power, the Saudi’s meek surrender brings to a close the long age of OPEC domination of the world’s energy market. This year truly has seen the death of one world order, along with the uncertain birth of another.

The details of the new OPEC pact make it clear that even this belated effort to quell the self-imposed bleeding brought on by Saudi attempts to drive U.S. shale out of the energy market – by, in Rockefeller style, over-producing to drive down prices and eradicate their competitors – is problematic at best. Related: Canada Fires Up Drilling Rigs On News Of OPEC Deal

OPEC as a whole agreed to cut 1.2m barrels per day (bpd) from production from the beginning of the new year, with the Saudis themselves bearing the brunt of the cuts with a personal reduction agreed to at just under 500,000 bpd. But as OPEC now accounts for less than half of all energy output in the world, it is a very weakened cartel, dependent on the kindness of strangers to survive.

Externally, this means Russia. The new global energy reality has been forthrightly addressed in the accord, as the interim deal is contingent on securing a further 600,000 bpd in cuts from non-OPEC members, with Russia expected to contribute 300,000 bpd to this total.

Unsurprisingly, the Kremlin is less than enthused, as Russian oil minister Alexander Novak blandly said that at best his country would only cut its production gradually, due to “technical problems”. OPEC isn’t much of a cartel if it is utterly dependent on major (and generally unwilling) outside players such as Russia to make its internal agreements work.

While the Saudis are hoping to persuade the Russians to go along with their fragile deal, to reach even this stage meant Riyadh wholly giving way to their hated enemy within the cartel, Iran. Related: Is This The Death Blow For The Dakota Access Pipeline?

Just recovering from years of sanctions due to its nuclear programme, all this past year as the Saudis have frantically tried to reach an OPEC-wide deal to cut their ruinous losses, Iran has held firm that it has no intention of hurting its just unbound economy to take one for the team. In the end, the Saudis had to meekly acquiesce, allowing Iran to continue to ramp up production, helping their sworn enemy in a way that must have put the House of Saud’s teeth on edge.

So even after surrendering to Iran, and assuming the Russians can be generally corralled to accept cuts of their own, there is a final problem with the Saudi inspired OPEC accord. The cuts are estimated to leave global oil production at 32.5m bpd, a historically high rate of supply unlikely to lead to much of a rise in the price of energy at all.

Even if prices sustainably drift upwards, all this will do is make American shale – far more price sensitive and far more capable of being quickly brought on line than the fixed rigs of the OPEC member countries – turn the spigots back on, with its production rising and the price consequently falling.

The Saudis, having utterly lost the plot, are now – as the problems inherent in this deal make all too clear – trapped in a world where they no longer control the global energy scene. It seems even the surrender terms the OPEC deal represents will not be accepted by Riyadh’s competitors. And they have no one to blame for this state of affairs but themselves.

Along with Europe as a great power, and America as the world’s ordering power, the myth of Saudi energy dominance is the third great dinosaur to be felled by the asteroid that is 2016.

By John Hulsman via City AM

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  • Prashanta Dhakal on December 05 2016 said:
    The alternative was to continue to run 25% budgetary deficits. One could argue they made the best possible decision under the circumstances. Had they been more clever in the past, they would have never let oil cross the $100/bbl mark which spurred the shale boom.
  • Dan on December 05 2016 said:
    Did they see the gigantic oil finds in Texas and figure, "what's the use"? Rather than starve their citizens with low oil prices and watching other countries buy out hurting oil companies around the world while their own cash reserves plunged, make money with what you have and when the Saudis release oil reserve data just say they only have a fraction of reserves to run up the price. Russian supply takes a while to cut doesn't it with super cold conditions within pipeline flows? Russia seems to be looking farther and farther North where those conditions only worsen. Giving a real indication of recoverable reserves for that country. The price war took its toll on other OPEC countries backing up your article further . Things changed.
  • DJ on December 05 2016 said:
    Years ago while still a teenager, I heard a radio interview with the then Saudi oil minister. Back then, Saudi was still the worlds oil super power. At the time, the interview was about Saudi inçreasing production to keep the price stable. When asked why, his answer was quite simple, "the more prices rise, the more the world will look for alternatives".
    Up until 2006/7, the oil price was quite stable below 40usd, give or take one or two blips, which over 100 years only marginally affected the average. Everyone one seemed happy. Then prices started to rise faster then anyone had ever seen. What amazed me even further, is how quickly budgets were readjusted for prices over 100usd. Then, as Prashanta pointed out, shale oil started to look like a viable option, and they opened Pandora's box. The shale boom started, and the consequential drop in prices, accelerated by other economic factors, started. This then spurned American enginuitty into gear (I am not American btw, but I am a fan of their solution based attitude), and the cost price of shale started to fall. Had Saudi kept the price in check, they may have held on to their crown.
    I believe they are closing the gate after the horse has bolted here. They have cut production, the price will most likely not move much, and they have given up market share.
    The best thing for them to do, is to rebalance their budgets and accept the new market. Countries that have been unable to adapt to market changes have placed themselves into almost irrecoverable situations. Look at Argentina's decline from the 1900's onward, or how about Egypt during the cotton boom brought about during the American civil war.
    No thought was put into what next...
  • Joe on December 05 2016 said:
    I don't agree that Saudi surrendered. They taught a valuable lesson to fellow Opec members about the consequences of not following quotas. Secondly, they taught a valuable lesson to banks who were too willing to finance the over exuberant shale drilling boom. The banks and oil companies were knee capped and are left with huge debts. If the shale drillers get overly active, the Saudis will flood the market again.
  • Observer on December 06 2016 said:
    Middle East has this "overdoing" problem.
    A few centuries back Ottomans overtaxed spices - and Europe sailed around Africa for the first time, switching the balance of power forever.
    Now the petroleum - prices shooting to sky to subsidize under-educated, over-indulged, fast growing population's luxurious dreams - till Americans made shale oil a reality.
  • just a dude on December 06 2016 said:
    the biggest demand for petroleum is created by people driving cars. in 20 years half of the cars will run on electricity, and after another 20 years all the cars will run on electricity.
    oil will cost pennies.
  • beelady on December 09 2016 said:
    just a dude: Excuse me, but what fuel is going to produce the electricity to charge all the electric cars you are fantasizing about. Cheapest and most reliable is coal, next is natural gas. Don't count on renewables. They can't provide either the reliability or the quantity. Solar at night? Monster batteries? Not really available and hugely expensive. Wind which doesn't always blow? Dream on.....
  • NickSJ on December 10 2016 said:
    If the new process for microwaving kerogen formations in Colorado proves out next year, OPEC will be in a world of trouble, as these formations are estimated to contain 4.2 trillion barrels, dwarfing OPEC's reserves. Technology marches on.
  • drp on December 10 2016 said:
    DJ - If Saudi had continued to keep prices at below $40/bbl previous to 2006/7, they would not have the income that they have now since their production now is about the same as it was in 2006. Their population and internal crude oil needs have increased, thus they have less oil to export. The world demand for oil peaked out of cheap oil and needed more crude oil, so prices were going to have to increase to get the 30% of expensive oil needed for world consumption of 94 mmbopd. The expensive unconventional crude is from tar sands, deep-water oil sources and shale oil.

    Its not an easy problem to meet the worlds oil needs and not have a increase in the price of crude. I say that if Saudi had not kept prices high, they would be worse off than they are now since their soverign wealth fund would have never had a chance to build up to the $750 billion that it was at in 2014. It would have been much lower than it was at 2014 due to selling oil at $40/bbl. The price of oil increased due to world demand, and increased cost to meet the last marginal expensive bbl.

    The US shale industry was as responsible for our surplus world crude supply due to ZIRP money policy. As long as banks would lend the shale oil companies would drill even though they were not profitable ---- they were running at negative FCF even when prices of oil where high. Oil prices are controlled more due to the futures market than Saudi. I just would not be so quick to blame the surplus oil situation on Saudi when it had more to do with zero interest rate money policy in the US. The US kept rates so low and lending was rampant. Regards.

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