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Why Saudi Arabia Won’t Cut Oil Production

Why Saudi Arabia Won’t Cut Oil Production

Nine months after OPEC decided to leave its production target unchanged and pursue market share instead of trying to prop up prices, the group is facing a set of complex problems and decisions going forward.

At first blush, the collapse of oil prices and the resiliency of U.S. shale appears to hand OPEC, and its most powerful member in Saudi Arabia, a stinging defeat. U.S. oil production has leveled off but has not dramatically declined. Meanwhile, oil prices are at their lowest levels since the financial crisis and the revenues of OPEC members have fallen precipitously along with the price of crude.

All of that is true, and in fact, Saudi Arabia is under tremendous pressure. The Saudi government is considering slashing spending by a staggering 10 percent as it seeks to stop the budget deficit from growing any bigger. The IMF predicts that Saudi Arabia could run a budget deficit that amounts to about 20 percent of GDP. Related: Some Small But Welcome Relief For WTI

The pain is manifesting itself in different ways. Not only will the Kingdom have to cut spending, but it has also turned to the bond markets in a big way. Low oil prices have forced Saudi Arabia to issue bonds with maturities over 12 months for the first time in eight years, raising 35 billion riyals (around $10 billion) so far in 2015.

At the same time, the currency is coming under increasing pressure. Saudi Arabia pegs the riyal to the dollar at a rate of about 3.75:1, but speculation is rising that the currency may need to be devalued, given that the oil producer won’t be able to defend that ratio indefinitely. On one-year forward markets, the riyal has already weakened to 3.79, according to the FT. That forced the government to issue a statement, saying that the Saudi Arabian Monetary Agency “is committed to the policy of pegging the Saudi riyal with the American dollar.” But if oil prices do not rebound, the government will have to continue to draw down on its foreign exchange in order to keep the currency steady.

All the damage inflicted upon Saudi Arabia has the world looking back towards Riyadh, especially after oil prices crashed on “Meltdown Monday.” The markets are trying to figure out if Saudi Arabia may switch tactics in order to stop the crash from worsening. Related: Oil Prices Driven Lower By Everything Except Fundamentals

Pressure is actually the greatest within the oil cartel. Algeria’s oil minister wrote a letter to OPEC’s secretariat requesting action, although the letter stopped short of a call for a production cut. Months earlier, before OPEC’s last meeting in June, Venezuelan officials pressed for a change in strategy to shore up oil prices. Venezuela is arguably the worst off member, as its economic and financial crisis worsens by the day.

More recently, Iran’s oil minister said that his country would increase oil production “at any cost,” but also supported an emergency OPEC meeting before the scheduled summit in December in order to discuss the group’s strategy. More and more members are clamoring for a cutback in the cartel’s production.

If Saudi Arabia’s strategy of pursuing market share has not worked, and even its colleagues inside OPEC want a policy change, perhaps Riyadh would reconsider and now decide to restrict production in order to boost prices? Related: Wind Energy Could Blow U.S. Coal Industry Away

That is more wishful thinking than a likely possibility. There is little chance that Riyadh would retreat now just as the worst pain is really beginning to set in for rival producers. Sure, Saudi Arabia is suffering from low prices, but its competitors are hurting worse. U.S. oil production, after years of blistering growth, has not only ground to a halt, but has started to decline. Output peaked in March at 9.69 million barrels per day (mb/d), dropping to 9.51 mb/d in May (the latest month for which accurate data is available). In all likelihood, the decline has picked up pace in the intervening months.

And more to the point, U.S. oil production will continue to decline the longer Saudi Arabia holds out. Several companies have already gone bankrupt, and more are no doubt coming down the pike. That will allow Saudi Arabia to achieve its goal of holding onto market share, and letting prices adjust on the back of rival producers.

To highlight this point, Saudi Arabia’s decision to cut its budget should be seen not as evidence that it is buckling under crushing weight of low prices, but that it is in the game for the long haul. It is shrinking its budget to fit a world of depressed oil prices, positioning itself to ride the wave as far as it goes. Cutting spending is actually a signal of the government’s resolve in regards to its current oil strategy, not a sign of wavering.

By Nick Cunningham of Oilprice.com

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  • Marty on August 26 2015 said:
    Just A few hours ago, Rafael Correa the president of Ecuador said that his country it's producing oil at a loss by $ 6.00 per barril . his country It's also an OPEC member..
  • Jim on August 27 2015 said:
    An important aspect of this turmoil that I would like to see covered is bankruptcy. North American shale players might go bankrupt, but their assets are likely to be sold for pennies on the dollar to a larger, stronger firm that could drill or pump in short order. Most other countries have nationalized assets that are developed or not over a longer time horizon at the whim of a few key governmental figures.

    If Saudi subjects riot over bread, the policy will end. On the other hand, North American players can pump easily as soon as oil hits a certain price. That flexibility in North American production suggests that prices will be capped over the next few years, unless OPEC can coordinate its own members and get Russia to cooperate. With China's engine stuck in second gear, demand worldwide could be choked for several years too. Saudi Arabia may want to keep pumping, but I cannot see any winners five years out.
  • Ken Pretty on September 01 2015 said:
    Tough times.K.
  • OlderOilMan on September 03 2015 said:
    For the past few months the EIA has provided notice that it was changing its reporting of US monthly production levels to a new, more timely and accurate methodology.

    Under this new methodology the EIA just released its revised monthly US production levels for Jan - Jun 2015 that shows as suspected, given the astonishing 60% collapse of the active rig count since Oct 2014, that it had been significantly over reporting monthly US production levels for the first 5 months of 2015 and revised production to lower levels.

    This EIA revision shows the U.S. actually produced 40,000 to 130,000 fewer barrels per day per month than the agency previously reported. US Production levels peaked in April 2015 at approx 9.6 million B/D, May continued in decline and in Jun US production had declined to just under 9.3 million B/D. Thus, US production declined 300,000 B/D or approx 150,000 B/D per month in just 60 days (end of April - Jun 2015). This rate of decline is very likely to accelerate in the coming months.

    For the last few months the EIA has been forecasting a continuing decline of approx. 100,000 B/D per month (for July - Aug) notwithstanding the very recently revised (lower) US monthly production rates for Jan - Jun 2015.

    The high decline rate of shale oil (80%) that represents approx 50% of the US production mix, masked the decline in US production levels in 2015; due to completions of the outstanding fraclog built up by the end of 2014. However, most all of these fraclog wells were wells drilled in 2014, not 2015.

    Further, by the revised EIA monthly production levels, its now clear completing the faclog wells did not add nearly as much monthly US production in 2015 as many had previously believed. Equally clear is the fact, notwithstanding the nominal increases in the rig count, shale producers have not been completing anywhere near enough wells to arrest their 80% natural decline, let alone continue increasing US production levels. As the fraclog continues to dissipate, significantly more drilling (capital/rigs) will be required to forestall an acceleration of the current decline rate of US production that began in May/Jun of 2015.

    Those in E&P know how difficult it is to arrest a production decline rate, let alone reverse it; near impossible without a significant infusion of capital for drilling or EOR. At these low and unsustainable oil prices, a significant infusion of capital is not at all in the cards.

    Therefore, one can expect the above EIA reported monthly decline rates (100,000 to 150,000 B/D per month) to not only continue for the foreseeable future, the month decline rate is likely to accelerate.
  • truthbe on December 30 2015 said:
    It is obvious the Saudi and surrounding empires only want to crush the American oil companies. They don't want to compete with American oil companies so they decide to crush them, even if it means taking a loss for awhile. They always controlled the price of oil, especially when we weren't pumping enough. Ruthless people they are, and if they win, they will stop pumping oil and eventually raise the price of gas to $10 a gallon to again destroy American economy.

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