Saudis Believe They are Winning The Oil Price War

It's almost a foregone conclusion that OPEC won't cut its production levels at its June 5 meeting in Vienna. Anyone needing strong evidence, if not proof, of this need only listen to Ali al-Naimi, the architect of the cartel's effort to reclaim market share.

In fact, some observers say OPEC not only won't cut overall production levels from 30 million barrels a day to shore up prices, but may even increase them. Related: The Evolution Of The Oil Weapon

It's important to remember that shoring up oil prices is not the highest priority on al-Naimi's list right now. While some OPEC members may have trouble making ends meet, wealthier Gulf Arab states can withstand lower revenues. This is especially true for Saudi Arabia, which has currency reserves of nearly $750 billion.

Instead, the strategy was a price war against non-OPEC members who were ramping up production, particularly those in the United States exploiting the boom in shale oil. The question, posed to the Saudi minister when he arrived June 1 in Vienna in advance of the cartel's meeting, was whether that strategy was working.

"The answer is yes," al-Naimi replied. "Demand is picking up, supply is slowing."

This isn't just wishful thinking. OPEC is, in fact, gradually reclaiming its market share, according to a June 2 report from Barclays. It said that the cartel captured an average market share of 33 percent in April, up by 1 percentage point from the same month last year, but still 35 percent below the share it controlled in the middle of 2012. Part of this recent growth is attributable to increased sales to China.

The comment by the Saudi oil minister can only be interpreted as a sign that a production cut isn't going to happen, according to Gareth Lewis-Davies, an energy strategist at the Paris-based financial services company BNP Paribas. Related: How Long Can OPEC Maintain Its Current Strategy?

"[Al-Naimi] said that Saudi strategy is working, which suggests that they therefore would like to continue with that policy," Lewis-Davies told Bloomberg on June 2. "They're playing a longer game that requires prices to remain at or around current levels for longer."

The reason is that many oil companies, particularly those who extract oil from shale, have higher production costs, primarily because of complex and expensive fracking, and a long stretch of lower fuel prices could cut deeply into their profits.

In fact some observers believe OPEC, under al-Naimi's influence, may intensify its strategy. One, Olivier Jakob, an energy analyst at Petromatrix, said the cartel might raise its output cap to 30.5 million barrels a day, reflecting today's actual production levels.

This makes sense to the consultancy JBC Energy in Vienna. It concludes that if every OPEC member is producing as much oil as it can, it would send a powerful message to non-OPEC members, especially producers of shale oil. It also said the move would "put the organization back into the driving seat, following some commentators' doubts of its relevance after the last meeting" on Nov. 27. Related: Top 5 Solar Markets in Asia

Al-Naimi's comments, combined with a slight drop in the value of the U.S. dollar, caused the price of Brent and West Texas Intermediate crude to inch up. The price of both types of oil crashed in the second half of 2014 because of the energy glut. Now the Saudi plan to reclaim market share has cut into U.S. oil production, with a 60 percent decline in drilling rigs.

So al-Naimi's assessment of his strategy seems to be correct: the approach is working, and it would be beneficial for OPEC if the strategy weren't abandoned at the organization's June 5 meeting.

By Andy Tully Of Oilprice.com

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