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Kurt Cobb

Kurt Cobb

Kurt Cobb is a freelance writer and author of the peak oil-themed thriller Prelude. He speaks and writes frequently on energy and the environment and…

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Could This Be Saudi Arabia’s Best Kept Secret?

Could This Be Saudi Arabia’s Best Kept Secret?

It is popular these days to speculate about why Saudi Arabia cajoled its OPEC allies into maintaining oil production in the face of flagging world demand. As the price the world pays for oil and oil products has plummeted, the price OPEC members are paying in terms of lower revenues is high, even unbearable for those who didn't save up for just such a rainy day.

Was the real reason for the decision to maintain production the desire to undermine rising U.S. tight oil production--which has now proven embarrassingly vulnerable to low prices after years of triumphalist talk from the industry about America's "energy renaissance"? Were the Saudis also thinking of crippling Canada's high-cost tar sands production? Was it Sunni Saudi Arabia's wish to undermine its chief adversary in the region, Shiite Iran? Was the Saudi kingdom doing Washington's bidding by weakening Russia, a country that relies so heavily on its oil export revenue?

The Saudis say explicitly that they believe non-OPEC producers must now balance world oil supply by cutting back production rather than relying on OPEC--meaning mostly Saudi Arabia--to do so. And, those cutbacks in the form of drastically reduced investment are already taking place in the United States, Canada and around the world as low prices are forcing drillers to scale back their drilling plans dramatically. It is not well understood, however, that almost all of the growth in world oil production since 2005 has come from high-cost deposits in the United States and Canada which has made the two countries easy and tempting targets for the Saudis' low-price strategy. Related: Oil Price Crash – What Next?

Recently, investment manager Jeremy Grantham opined in Barron's that Saudi Arabia has probably made the wrong decision. He explains as follows:

[T]he Saudis could probably have absorbed all U.S. fracking increases in output (from today’s four million barrels a day to seven or eight) and never have been worse off than producing half of their current production for twice the current price … not a bad deal. Only if U.S. fracking reserves are cheaper to produce and much larger than generally thought would the Saudis be right. It is a possibility, but I believe it is not probable.

First of all, he vastly overestimates the ability of the United States to increase its RATE of production, though he correctly assesses the production cost and longevity (or lack thereof) of U.S. tight oil reserves. Even the ever-optimistic U.S. Energy Information Administration believes that U.S. oil production will plateau in 2019 (not far above where it is now) and start to decline after 2020.

But, my concern is with Grantham's assertion that the Saudis could have let U.S. drillers simply drill away while OPEC countries--meaning again, mostly Saudi Arabia--reduce their production without being worse off financially than they are now. U.S. tight oil production would presumably play itself out by 2020 or so and then start to decline allowing OPEC to recapture market share and raise prices again.

But there is one possibility which Grantham is blind to, one mentioned to me by a friend. It's a big what-if. But then pretty much everything is a what-if when it comes to the secretive Saudis.

What if the Saudis are acting now to undermine U.S. and Canadian oil production because they realize that Saudi production will soon reach a peak, level out for several years and then start to decline in no more than, say, a decade? What if the Saudis fear that energy efficiency, fuel substitution (say, toward natural gas), and mandated greenhouse gas emission reductions will inevitably diminish their oil revenues beyond the next decade? What if this coming decade will therefore be the best time to maximize Saudi revenues per barrel? It would then make sense for the Saudis to cripple North American production now with, say, a year of low prices which should be enough to make investors skittish for many years thereafter. Then, the Saudis can capitalize on higher prices during the next nine years as the kingdom experiences its peak flows and before energy use reduction strategies threaten oil revenues. Related: After Saudi Arabia Crushes US Shale Who Will It Go After Next?

(This assumes that they are right about the reluctance of investors to return to the tight oil fields and tar sands after having been walloped by the current low prices, something that would slow or prevent further growth in U.S. and Canadian oil production. If investment returns readily with any price increase, it is possible we could see wildly fluctuating prices due to short boom/bust cycles in the U.S. and Canadian oil industry, something I regard as possible but unlikely. This is because I expect many if not most of the current tight oil leases to pass into the hands of the major international oil companies as a result of bankruptcies of and distressed sales by the independent tight oil players in the coming year to 18 months. Those majors will take a more measured and patient approach to the development of those leases).

Now, of course, no one knows what the Saudis know about their own oil reserves or anticipated flow rates. Saudi Aramco, the Saudi national oil company which controls all oil development and production in the country, is 100 percent owned by the government and therefore is not obliged to release information to the public nor submit to an outside independent audit. But the Saudis have already publicly stated that the world cannot count on them for more than 12.5 million barrels per day (mbpd). The country currently pumps about 9.7 mbpd of which it exports about 6.9 mbpd.

If the Saudis are acting now to cripple U.S. and Canadian production for the reasons my friend suggests, it means world oil supplies are going to be much more problematic after 2020 than many people suppose. It implies that at some point in the next 10 years OPEC will cease to be able (rather than cease to be willing) to balance world oil supplies. And, it suggests that no one else will be ready to act in that role when the time comes.

By Kurt Cobb of http://resourceinsights.blogspot.mx/ 

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  • Stavros Hadjiyiannis on February 23 2015 said:
    This article makes so much sense.

    In fact I doubt whether the Saudis are able to ever increase their output from current levels. Have they ever produced at 12.5m/bbl? No!

    In fact, the only country that will be able to do that in the future is Russia (everyone in the industry knows that Russian oil reserves are vastly understated by everyone involved) something that also explains the maniacal hysteria against Russia in the West today.
  • John Scior on February 23 2015 said:
    Its nice to know that given American innovation in fracking technology and electric cars as well as biofuels and ethanol/methanol/synthetic fuels, we capthe amount which oil producing countries have in potential ability to gouge us at the pump with overpriced crude. We can always fuel our cars but can you eat your crude oil ??? If so, for how long will it last ?
  • Steve on February 26 2015 said:
    They might be more scared of Tesla and Apple building electric cars.
  • Ross Petersen on February 27 2015 said:
    Something that the Saudi's don't have to trouble with, is their own gov't interference from over-zealous regulatory standards: OSHA, EPA, OBAMA... "From out of the North will arise a super-power, who will impose destruction to the world like never before." Russia, should be it, but who knows? I am just amazed at how our own politicians continue to impose stalling measurements against American innovation and excellence...
  • Major on March 13 2015 said:
    Those EMH supporters who believe that market's automatically set the "best" price for an openly traded commodity should simply fold their tents and go home in shamed embarrassment at the current phenom of soaring gasoline prices, in the face of plummeting oil prices -- and pleas for the most efficient producers to slow down production -- while insisting that the least efficient, most polluting, be most subsidized increase their output. All this in the face of GLB and CFMA legislation enabling banks to "front run" commodities prices while conducting huge (non-hedging) commodity purchases and sales!

    We're obviously long overdue for repeal of both GLB and CFMA -- together with a hefty Tobin tax on commodity trading, (non-hedging) financial derivatives and carry trade: and all other such zero value-added speculation -- serving only to increase economic rents on the real economy.
  • Ahab Shiek of the Burnin Sands on March 17 2015 said:
    None of that matters. Those who are in power are deeply entrenched by means of their ridiculously large financial position. They cannot be knocked off their perch, so what happens with oil and oil producers is irrelevant.

    "They" call the shots. It will always work out for 'their' further enrichment.
  • awr on March 23 2015 said:
    But then, if that is the case, sure the US would bomb them by now. Yet, the US making record high arms sales to Saudi.

    I think this is about putting the small shale companies into the hands of big oil companies at dirt cheap prices. Then letting the price of Oil shoot up, allowing the big oil firms (and Saudia) profit at the same time.
  • Reda on August 21 2015 said:
    oil will still be the fuel of this world, at leat before 2200 if the world doesn't end by then.
    some say renewble energy, some say electric cars (AGAIN NEEDS LITHIUM AND HOURS TO BE CHARGED),we surely see hybrid cars,but all these solutions are to limit the ever growing demand on oil,food,energy,transportation and oil related chimicals envolved in everything not to mention the birth of new industrial nations every generation soon every decade.the oil price will stabilize at 110$/baril with supplies covering the new demande due to unconventionnal oil production in the USA,CANADA and VENEZUELA (the largest proven reserves in the world with 300 bbl) and these countries will control the price of oil + all of russian oil fields are old now that why Russia is building up it navy, airforce to protect it oil reserves in arctic (a new koweit in the Russian EEZ) so oil production will continu to increase thanks to deep sea drilling and unconventionnal ressources.
    Saudi arabia had always produced 9000000-1100000 baril/day so where is the problem, the oil prices fell because of the situation the the EUROZONE and the slowdown of the chinese economy + lower global demande
    saudi arabia has maintained the production at 10 million barils/day to protect the share of Libya a felow OPEC member (down from 2 million baril to 300 thousand baril/day).
    let say the saudis reduced their oil production from 10 to 9 million barils, Iran or Iraq will fill that void for the same reason, the market share, and the regime rulling both in iran and iraq is considerated as an ennemi, and the war in yemen and syria is part of that cold war in the middle east.
    to sum up, saudi arabia wants to protect it market share by maintaining a prodution level of +9 million baril/day and wait for the prices to go up on their own.
    let just say that it's like the oil glut in 1986, the history is repeating it self, the oil prices went up after the war in iraq up from 30$ to 120 $ i guess the bubble exploded due to the same reason in the 1980s,investment in oil technology, in 1980s the world invested in Nuclear energy and the 7 sisters in deep sea oil drilling, now the world is investing in renewble energies and the shale oil, it will take 5-10years for the oil to be expensive again (do not the demographic bomb in subsaharian africa, and also the Russian arctic reserves, unconventionnal oil in the americas,and oil in south china sea).
    we might see wars in the middle east (iran vs the arabian penisula +US),asia (China vs the US in south china sea or China vs the US + Japan maybe US+Taiwan),NATO or US only vs Russia in the Arctic for the same reason OIL
    that will make oil price sky rocket to 150 $/baril .so everything can happen

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