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Osama Rizvi

Osama Rizvi

Osama is a business graduate and a student of international relations. Currently working as freelance journalist, covering commodities and geopolitics.Osama is a regular contributor at 'Modern Diplomacy'…

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Who Holds The Power In Today’s Oil Market?

Oil storage

Amidst the din of analysts speculating about whether oil prices will rise or fall, observers may well be overlooking some pressing questions about the very nature of the global oil market. The most significant of these questions relates to whether Saudi Arabia is losing its grip on the global oil market and if U.S. oil and gas producers are replacing the Saudis as the key global swing producer.

By the mid-70s, the Kingdom of Saudi Arabia wielded the power to swing oil prices at its will by turning on and off the taps. Presently, after 44 years, the scenario is quite different. In fact, the recent Vienna accord where OPEC and NOPEC producers agreed to cut 1.8mbpd of oil, and now its possible extension, is symptomatic of the internal weakness. In 2014 when Saudi Arabia refused to cut production to stabilize prices, and instead increased production to protect market share, an oil price war began. But the strategy to drain out the high cost producers has gone awry. U.S. production continues to rise, while Saudi Arabia’s economy is suffering from lost oil revenue. U.S. Shale producers appear to be recovering market share and have managed to lower breakeven prices through a technological revolution.

Welcome to the era of “Fracking 2.0”, where a “company man” 100 miles away from an oil rig can give instructions to his workers via an app called “ISteer.” EOG Resources, one of the largest independent oil and gas companies in U.S. and ranked as Texas’ fifth largest gas producer, is doing wonders as it outperforms its competitors. EOG can now drill horizontal wells in just 20 days, which is down from 38 in 2014. The company has pumped consistent quantities of oil irrespective of the drop in prices.

And that is just one example. Related: Petrobras Reports 2.74M Bpd Daily Output For March

At the same time, the production cost per barrel of oil for U.S. shale operators has decreased. Rystad Energy says that the break-even cost for U.S. shale is now $35 per barrel. Only recently such costs were three times higher than the Middle East and other non-Western producers and the depletion rate for such producers were much more punishing. But now the recovery rate, from 5 percent to 12 percent, may reach 25 percent in coming years. It is not a matter of if but when this technological revolution extends across all oil-producing regions outside the Middle East. There is strong evidence of the aforesaid rising oil production as well, with the EIA forecasting a U.S. daily crude output of 9.2 million barrels this year. It is expected to reach 9.7mpd in 2018. The rise in oil prices and U.S. production are directly proportional. This is one of the reasons that, as prices have recovered over past few months, we have witnessed a historic build in inventories.

(Click to enlarge)

While the U.S. experiences this continued growth, Saudi Arabia has no option but to curb production and stabilize oil prices as more than 90 percent of their revenue depends on oil exports. In 2015 the Saudi’s were burning through their foreign exchange reserves at a perilous rate, which can create inflationary pressures. Saudi government subsidies and public entitlements were reduced while salaries and holidays were cut. The Deputy Crown Prince, Muhammad Bin Salman, faces an important and difficult task: stabilize the economy or face popular unrest. Therefore, the Kingdom, in an effort to wean itself off oil, launched “Saudi Vision 2030” and the “National Transformation Plan 2020.” The planned IPO of Saudi Aramco, the Kingdom’s national oil company, is a part of the Kingdom’s recovery strategy. By selling a five percent stake of this company, which according to some estimates is worth one trillion U.S. dollars (enough to buy Google, Apple, Berkshire Hathaway and Microsoft combined), the Kingdom is set to create the world’s largest sovereign fund. Such a step would diversify its economy and possibly eliminate the Kingdom’s greatest threat: social unrest. And now that there is a production cut with a more than 90 percent compliance rate, the Kingdom may be feeling more secure. In fact, according to reports, the Saudi’s economy has started to recover. Related: Goldman’s $50 Forecast May Prove Bullish

The OPEC deal, which was set to expire after the first six months of 2017, is likely to be extended for another six months which, given the importance of oil prices for Saudi Arabia’s economy, may mean the difference between survival or destruction.

Another positive move from Saudi Arabia is the reduction in tax rate for Saudi Aramco from 85 to 50 percent. This will help in ramping up Aramco’s value, which is the main revenue earner of the country. Saudi Arabia appears to have come to terms with the fact that it can no longer control the oil markets, and instead is focused on attempting to protect its economy.

Rising rig count, ballooning inventories, advances in shale technology and the already present supply glut. These are few of the signs that, notwithstanding the efforts by the OPEC producers to stabilize markets, the fundamentals remain unchanged and U.S. producers are regaining their strength. If the trend continues, will we see the U.S. emerging as a new swing producer?

In the world of oil there may well be two swing producers now. One is young and growing while the other is struggling to keep up with the times.

By Osama Rizvi for Oilprice.com

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  • Jack Ma on April 15 2017 said:
    There is a 400 million barrel error in the supply chain and it is fake paper oil used to drive prices in the ground. Russia did not collapse, however. Now there is a 1 trillion dollar cap ex shortfall. The entire topic of swing producer is now a moot point. If all oil available gets to market, this is still not nearly enough to meet demand in the coming years. There is a massive shortage on the way and there is absolutely no way to stop it now. Momentum has been set in place. Dollar wars rage on. Make your bets. Fracking and the SA IPO out of desperation are both the 5% joke. SA is bankrupt now and this too is a forgone conclusion. They are now camping g out in tents at the debt markets.
  • Timmie Tee on April 16 2017 said:
    If SA wants a successful IPO of Aramco they need oil to be in the $50-60 range... so they will extend cuts w/ or w/o OPEC....

    US shale is extremely overrated in its long-term effect on supply... Shale wells deplete 72% over a two-year period, and are not a sustainable long-term solution.... also expect more regulation against shale because of its environmental effects.

    Here I'm still long, expecting $60 by eoy... and $70 by 2018... low E&P budgets will finally catch up and hit the supply side, along with heightened geo-pol risks...

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