Earlier this week, the U.S. lost a hard-won title… and honestly, we shouldn’t be complaining.
Reports came out that Saudi Arabia once again became the world’s largest oil producer. After months of lagging behind U.S. shale drillers, production finally slipped far enough to let the Saudis catch up.
And for some reason, the country seemed happy about this.
I mean, congratulations on the massive increase in oil production!
Even though we’re in a glut…
Even though it was overproduction that caused it in the first place…
The reports were posted with pictures of the Saudi prince looking smug. If that was his real reaction to the situation, it must’ve been covering up a much less enthusiastic emotion.
Why the Long Glut?
The price of oil seems capped under $50. It’s been stuck there for almost two years now. Originally, analysts expected the price to recover significantly by the end of this year.
But that’s no longer the forecast. The International Energy Agency now expects prices to remain in the doldrums through the first half of 2017 at least.
This switch in confidence is due in large part to all that Saudi smugness.
In late 2014, the country saw that prices were dipping because of new supply brought online by U.S. shale drillers using hydraulic fracturing.
Since fracking was still a relatively expensive pursuit at the time, Saudi Arabia figured that if prices continued to drop, those shale drillers would be forced to shut down. So they kept right on pumping like nothing was wrong.
When shale producers adjusted to the new low prices, Saudi Arabia enacted a perfect performance of insanity by trying the same thing again and expecting it to turn out differently.
Two years later, shale drillers are in an even better position than they were in 2014. Drilling and completion costs have been cut in half, and production continued to rise for most of that time despite the collapsing number of operational drilling rigs.
Even though the price of oil has bombed to less than half of its 2014 highs, drillers have been able to make their supply competitive at the reduced prices.
Not all the drillers, mind you. Plenty have closed up shop or been acquired in the past year, but those that have survived this long are here to stay. That’s not to say they’re not losing money, but most only need to see oil near $50 to keep operations running smoothly.
Compared to Saudi producers who need oil to be between $60 and $100 per barrel, they’re better off in the long term. And worse, the break-even price of oil may be the least of Saudi Arabia’s problems.
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The REAL Price of Oil
Saudi Arabia is king in the oil market for a reason. It’s the world’s top producer, has the world’s second-largest reserves, and is the unofficial but unquestioned de facto leader of the Organization of Petroleum Exporting Companies (OPEC).
So it should come as no surprise that the country has tied more than half of its GDP to oil. In 2014, this single commodity accounted for 85% of the country’s export revenues and 90% of its government revenues.
In the era of $100 oil, that meant the country was living large. But its own defensive maneuvers have backfired and left it scrambling to diversify.
Yet, for all the talk the media has done about Saudi Arabia weaning itself off of oil, it sure is trying hard to keep its production up and hold tight to every scrap of market share it can. The country’s production hit a new high of 10.67 million barrels per day in July, and it continues to tout a full capacity as high as 12 million.
We’re in a major glut, as I’ve said. The obvious solution would be for everyone to cut back and let prices recover a bit. But, as you’ll know if you’ve been following the saga via Keith’s updates, that has not come even remotely close to happening.
And the cost is coming right out of Saudi pockets.
Since prices dropped so dramatically, Saudi Arabia has had to cut its annual budget by about 25%, reduce subsidies for oil businesses, and subsequently increase energy taxes on its citizens. Aside from causing a new run of social backlash, all of this still hasn’t stopped the country from tapping into its reserves.
Thus far, hedges from years past have kept the country afloat. But those have been drained by nearly $190 billion since this mess began, according to Business Insider.
Now, Saudi Arabia isn’t quite as desperate for a recovery as, say, Venezuela, but “better than falling apart” is not “good,” either. And now even Russia, another major producer outside of OPEC, is seriously considering negotiating a freeze with the stubborn oil king.
Truth is, it may be too late for both of them; we’re already past the point of no return.
A Losing Game
U.S. rig counts dropped dramatically with the price of oil, but they’ve been inching back upward even though prices have hit their current ceiling. And if prices continue to rebound, more will come back online. Much of the spending has already been done; all that’s left to do is turn on the taps.
The U.S. can wait for this eventuality because as a new entrant into the oil export business, its economy isn’t tied to oil like Saudi Arabia’s.
They’ll keep spending, and we’ll keep pumping until something finally gives.
Even if this imaginary freeze comes to fruition, it’ll just mean more room for resilient U.S. producers to come back online.
It’s too late to go back to the way things were. Shale is too flexible to be entirely drowned out by a glut like this. And the companies that are preparing for the worst now will be well prepared to deal with oil staying low into 2017.
So, cheers to Saudi Arabia for taking back the title. I hope it’s worth it.
Until next time,
Megan Dailey
Energy and Capital
