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Simon Watkins

Simon Watkins

Simon Watkins is a former senior FX trader and salesman, financial journalist, and best-selling author. He was Head of Forex Institutional Sales and Trading for…

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Why Saudi Arabia Will Lose The Next Oil Price War

US Saudi Flags

Saudi Arabia has instigated two oil price wars in the last decade and has lost both. Given its apparent inability to learn from its mistakes it may well instigate another one but it will lose that as well. In the process, it has created a political and economic strait-jacket for itself in which the only outcome is its eventual effective bankruptcy. OilPrice.com outlines why this is so below.

The principal target for Saudi Arabia in both of its recent oil price wars has been the U.S. shale industry. In the first oil price war from 2014 to 2016, the Saudi’s objective was to halt the development of the U.S. shale sector by pushing oil prices so low through overproduction that so many of its companies went bankrupt that the sector no longer posed a threat to the then-Saudi dominance of the global oil markets. In the second oil price war which only just ended, the main Saudi objective was exactly the same, with the added target of stopping U.S. shale producers from scooping up the oil supply contracts that were being unfilled by Saudi Arabia as the Kingdom complied with the oil production cuts mandated by various OPEC and OPEC+ output cut agreements.

In the run-up to the first oil price war, the Saudis can be forgiven for thinking that they stood a chance of destroying the then-relatively nascent U.S. shale sector. It was widely assumed that the breakeven price across the U.S. shale sector was US$70 per barrel and that this figure was largely inflexible. Saudi Arabia also held record high foreign assets reserves of US$737 billion at the time of launching the first oil war. This allowed it room for manoeuvre in sustaining its economically crucial SAR-US$-currency peg and in covering any budget deficits that would be caused by the oil price fall. At a private meeting in October 2014 in New York between Saudi officials and other senior figures in the global oil industry, the Saudis were ‘extremely confident’ of securing a victory ‘within a matter of months’, a New York-based banker with close knowledge of the meeting told OilPrice.com. This, the Saudis thought, would not only permanently disable the U.S, shale industry but would also impose some supply discipline on other OPEC members. Related: Will U.S. Shale Ever Return To Its Boom Days?

As it transpired, of course, the Saudis had disastrously misjudged the ability of the U.S. shale sector to reshape itself into a much meaner, leaner, and lower-cost flexible industry. Many of the better operations in the core areas of the Permian and Bakken, in particular, were able to breakeven at price points above US$30 per barrel and to make decent profits at points above US$37 per barrel area, driven in large part through advances in technology and operational agility. After two years of attrition, the Saudis caved in, having moved from a budget surplus to a then-record high deficit in late 2015 of US$98 billion. It had also spent at least US$250 billion of its precious foreign exchange reserves over that period that were lost forever. In an unprecedented move for a serving senior Saudi politician, the country’s deputy economic minister, Mohamed Al Tuwaijri, stated unequivocally in 2016 that: “If we [Saudi Arabia] don’t take any reform measures, …then we’re doomed to bankruptcy in three to four years.”

The even more enduring legacy of this first oil price war, though – and part of the reason why the Saudis could never hope to win the last one, or any future oil price war either – is that it created the resilience of the U.S. shale sector as it now stands. This means that the U.S. shale sector as a whole can cope with extremely low oil prices for a lot longer than it takes Saudi Arabia to be bankrupted by them. Saudi Arabia has much greater fixed costs attached to its oil sector, regardless of how low market prices go. Before the onset of the latest oil price war, the Kingdom had an official budget breakeven price of US$84 per barrel of Brent but, given the economic damage done by this latest price war folly, it is much higher now. By stark contrast, the U.S. shale sector that Saudi crucially helped to shape in the first oil price war is now so nimble that US$25-30 per barrel of WTI is enough to bring some of the production back on line, as long as operators believe that prices will not fall and hold below the US$20 per barrel level. But, even if prices are below that key US$25-30 per barrel level, it does not matter to the long-term survivability of the U.S. shale sector as the key players are able to shut down wells instantly as and when needed and to start up them up again within a week as demand requires. In sum: in any oil price war, the Saudis simply cannot wait out the U.S. shale sector.

On the other hand, though – in a rising oil price environment - the Saudis are also doomed. This is because the U.S. – even before the latest oil price war – had intimated that it would not tolerate oil prices above around US$70 per barrel of Brent. When the oil price rose last year during the March-October period consistently above US$70 per barrel level, U.S, President Donald Trump Tweeted about Saudi Arabia’s King Salman that: “He would not last in power for two weeks without the backing of the U.S. military.” The US$70 per barrel level is considered one that brings into view oil price levels that might pose problems for the U.S. economy. Specifically, it is estimated that every US$10 per barrel change in the price of crude oil results in a 25-30 cent change in the price of a gallon of gasoline, and for every 1 cent that the average price per gallon of gasoline rises, more than US$1 billion per year in consumer spending is lost. Related: OPEC+ Agrees On Extending Record Output Cuts

Before this latest Saudi-instigated oil price war, the U.S. had little interest in the fact that this US$70 per barrel level was way below Saudi Arabia’s then-budget breakeven oil price. After this latest attack on its strategically vital shale sector, the U.S. has absolutely no interest whatsoever in this budget breakeven fact or indeed in whether Saudi Arabia continues to slowly haemorrhage into bankruptcy in the coming years, according to a number of Washington-based sources close to the U.S. Presidential Administration spoken to by OilPrice.com in the last few weeks. Partly this indifference is due to the perceived ‘betrayal’ of the foundation stone deal that had determined the two countries relationship since 1945. This was that the U.S. would receive all of the oil supplies it needed for as long as Saudi Arabia had oil in place, in return for which the U.S. would guarantee the security of the ruling House of Saud. This altered slightly with the advent of the U.S. shale sector to ensure that Saudi Arabia also allows the U.S. shale industry to continue to function and grow.

Partly as well, this indifference is due to the series of other blunders that senior U.S. politicians believe have been made by Saudi Crown Prince Mohammed bin Salman (MbS), which now make him a liability. This includes – but is not limited to – the Saudi-led war in Yemen, the cosying up of Saudi to Russia in the OPEC+ grouping, Lebanese President Michel Aoun’s allegation in 2017 that then-Prime Minister Saad al Hariri had been kidnapped by the Saudis and forced to resign, and the murder of dissident Saudi journalist, Jamal Khashoggi, which even the CIA concluded was personally ordered by MbS.

These factors culminated in President Trump making his earlier Tweeted implied threat about the fragile hold that the al-Sauds have on power in Saudi Arabia without U.S. assistance into a guaranteed promise during a telephone conversation on 2 April with MbS. During this call, Trump reportedly told MbS that unless OPEC started cutting oil production (with the implication being to push up prices to levels where the U.S. shale producers could start making decent profits) then he would be powerless to stop lawmakers from passing legislation to withdraw U.S. troops from Saudi Arabia. Shortly thereafter, MbS did what he was told. The change in this rhetoric from implied threat to guaranteed action means that this is now in the fabric of all future U.S. dealings with Saudi Arabia and it brings the Saudis crashing back to the basic problem. That is: economically it cannot afford to continue to crush oil prices for long enough to cause sustained damage to the U.S. shale sector, politically it is not permitted to allow prices to rise high enough to avoid eventual effective bankruptcy, and any pricing in between just allows the U.S. shale sector to make greater profits and grow even more. In this regard, the OPEC+ production cuts are perhaps the cruellest cut of all for the Saudis: the Saudis have to implement them and abide by them because they are needed to keep oil prices high enough to ensure the profitability and growth of the U.S. shale sector but the cuts cannot continue for long enough to allow the Saudis back into an ongoing budget surplus.

Already in this context, March saw Saudi Arabia’s central bank depleted its net foreign assets at the fastest rate since at least 2000, falling by just over SAR100 billion (US$27 billion). This is a full 5 per cent decrease from just the previous month, and the total reserves figure now stands at just US$464 billion, the lowest level since 2011. It leaves only US$164 billion of ‘fighting reserves’ that can be used on everything else that Saudi needs when the US$300 billion that is estimated to be needed to keep the economic cornerstone SAR/US$-peg is subtracted. At the same time, the Kingdom slipped into a US$9 billion+ budget deficit in the first quarter and a number of independent analysts are predicting that its overall gross domestic product could shrink by more than 3 per cent this year (the first outright contraction since 2017 and the biggest since 1999), whilst the budget deficit could widen to 15 per cent of economic output.


By Simon Watkins for Oilprice.com

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  • Maxander on June 08 2020 said:
    Saudi Arabia being a oil rich nation will always have oil under its soil evrn if the rest of the world empties its oil reserves.
    & that will lead to a fact that will be in favor of Saudi Arabia which will have it as a nation with only oil left on planet. Well offcorse that is 2050 I am talking about.
    But looking at short term picture of 5 years, America seems to be rapidly losing its recoverable crude oil reserves to almost zero. In that case, I think that world's oil rich nations will have upper hand in production, supply controlled crude oil prices.
    Demand for crude oil will continue to remain till the last drop of oil left on planet.
  • Mamdouh Salameh on June 09 2020 said:
    If the Saudis learnt the lesson of the latest oil price war they waged against Russia, they won’t venture into another war because they will lose it as they did the last time but this time with catastrophic repercussions for their economy and the stability of their country.

    Still the mistakes Saudi oil decision makers continue to make stagger me. The very latest is that Immediately after OPEC+ extended production cuts of 9.7 million barrels a day (mbd) until the end of July and at a time oil prices were in an upward momentum rising beyond $43 a barrel, the Saudis and their allies which had curtailed production by more than the their agreed quota signalled that those extra reductions won’t continue after June. They could have waited a bit until the impact of the extension has had time to sink in deeper in the market.

    Since the early 1980s Saudi Arabia has unsuccessfully wielded the oil price war weapon three times and not two times as the author indicated. The first in the early 1980s as part of a CIA-Saudi conspiracy to expedite the downfall of the Soviet Union with the Reagan administration starting a costly arms race and Saudi Arabia depressing oil prices by flooding the market. Saudi Arabia ended bankrupting itself in the service of the United States.

    The second time was in the aftermath of the 2014 crude oil price crash. Yet again, Saudi Arabia ended up losing $118 bn in oil revenue. This led to a war of attrition with US shale oil.

    The third time was on the 9th of March against Russia. Despite the bravado, Saudi Arabia lost the war. If it continued with the war, it could have ended depleting both its sovereign wealth fund and its stored oil not to mention ending probably with bankruptcy of its economy and destabilization of the country.

    US shale oil industry will emerge from the pandemic leaner but with hardly any influence in the global oil market. It will be kept on a life support machine paid for by US taxpayers. And with a breakeven price ranging from $48-%68 a barrel, US shale oil producers need prices above $70 to start raising their production. US shale oil drillers might manage to muster a production of 7-8 mbd thus propelling US crude oil imports from 9 mbd in 2019 to a projected 11-12 mbd in the next two years.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London
  • mazhar memon on June 09 2020 said:
    Saudi Arabia must review their policies in middle east and their dependency status on united states as it has caused nothing but disaster for them and world however above article is suggesting that only purpose of Saudi Arabia and its oil is to support politics and economy of united states. Article also suggests that Saudi Arabia is just a light smoke and it can be blown away by united states any time. On part of united states this could be taken as state gangster ism but under Trump we have come to understand that they don't care about such reputation, however Saudi Arabia must think where they are going.
  • Tom Kitta on June 09 2020 said:
    Spot on analysis. SA is more or less heading down. Oil needs to be extracted now or max 10 years into the future before it will not longer hold any or much value.
  • Bill Simpson on June 09 2020 said:
    I see an Iranian invasion through Iraq and Kuwait, probably during the first part of the next decade. Saddam screwed up by not pushing into Saudi Arabia and seizing their air bases and oil terminals, before the USA could respond. The same religious group as rules Iran lives in the oil region of Saudi Arabia, so they will welcome their Muslim brothers to liberate them from Sunni rule, especially after the free Saudi government money runs out, sometime during the latter part of this decade.
    The Europeans has better be ready to pay up a LOT for their imported oil, after Iran controls most of the world's cheap oil supply around the Persian Gulf, because the Iranians will not be giving it away, and Russia will have every incentive to keep the oil price sky high, along with the Iranians.
    The Chinese economy will take a big hit, unless they can ramp up their military enough to invade the Middle East in order to secure their oil supply. If they ever teamed up with India, in the absence of the USA, they could take over Kuwait, Saudi Arabia and the UAE, unless the Europeans jumped in first. That is unlikely, since the Europeans would never agree to invade anywhere. And without USA help, it would take an all out effort for them to secure and hold the oil fields. That won't happen.
    Of course, the US is rather unlikely to pull out of the Middle East, due to the close relationship between the US business and political elite, and Israel. Nobody wants nukes getting used to defend Israel in a war of attrition with Iran along its borders, since that could soon lead to the nuclear apocalypse. Nobody wins that one. Oil is not much use if you are dead.
  • Seth D on June 11 2020 said:
    This brilliant analysis by Simon Watkins should be required reading by anyone that has more than a passing interest in U.S. Shale, the Saudis, and the price of oil. I have bookmarked this column.
  • Sun God on June 11 2020 said:
    No doubt MbS would prefer a do over on the Khashoggi fiasco, and he also didn't understand that $70 oil would not shut down Permian Basin shale. The minute the first surplus drilling rig appears, almost all costs fall by roughly 25 to 30% in the onshore US oil patch. So, in 1974 he had to plumb the price depths and see what happened to US shale.

    That doesn't mean MbS doesn't know what he is doing. IMO the second price war was purely a foreign policy move. He was making sure the Russians didn't supply Teheran with a modern air defense system. This pleased both Washington and Beijing who want cheap and reliable oil.

    A modern air defense system would give Teheran enough time to sprint to maybe just one bomb, but that single bomb would threaten the existence of Ras Tanura. I think higher oil prices would be an immediate result.

    Back in the 90's the Saudi's tried $15 oil during the Jordanian succession crisis. This left Saddam with zero netback and hence no money to meddle in the Hashemite Kingdom of Jordan. The same zero netback situation faced Russia recently. Evidently, Russia said uncle. Now, we can expect oil prices to return to "normal" once demand recovers. Saudi retains plenty of forex.

    About the only long term take away I see is that Saudi's feel they have plenty of cheap oil to last a lifetime. I wonder if fracking works in Ghawar?

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