The Hidden Saudi Oil Crisis

Two weeks ago, I left you to ponder which side would blink first in this modern-day oil war.

Well, it was the Saudis that broke first… but probably not for the reasons most would think.

Most people want to think the Saudis don’t want to relinquish any of their market share to the U.S. — that they are exerting downward pressure on oil prices to force independent drillers in the Lower 48 to cut production.

But maybe — just maybe — OPEC’s largest oil producer has more to fear from the repercussions of $80/bbl oil than American drillers.

First, let’s take a look at what happened…

Crude War Casualties

It all started in September.

While oil prices in London declined nearly 7% as the bears took charge, the Saudis were quietly taking oil off of the market.

Keep in mind, however, that they weren’t producing less oil — just simply holding back some supply. Last month, Saudi Arabia exported approximately 9.36 million barrels per day, a little more than 300,000 barrels less than it supplied in August.

Assuming we can trust their output numbers (we’ll take them at their word for now), the Saudis were extracting about 9.7 million barrels of oil per day out of the ground.

And with 264 billion barrels of oil in proved reserves (again, trust issues aside), one of the lowest production costs per barrel on the planet, and the ability to boost output to more than 13 million barrels of oil per day, it’s easy to think the Saudis would have a huge edge in any oil supply war.

In fact, the Saudis’ advantage is even greater when we factor in the high drilling and completing costs, as well as the steep decline rates associated with tight oil production in North America.

So what has changed in such a short period of time to cause the Saudis to cut production?

What changed, indeed…

All’s Not Quiet on the Middle Eastern Front

I don’t think enough people realize the gravity of the situation for the Saudi Kingdom. Doom-and-gloom antics aside, I’m trying to suggest the Saudis will crumble in a matter of months.

However, it’s impossible to ignore the reality that young Saudi princes are facing going forward.

As I’ve said several times in the past, the Saudis are becoming addicted to their own drug. According to the last BP Statistical Review of World Energy, Saudi oil consumption has been growing steadily for the last decade — up about 53% over that time.

And at this rate, it’s only a matter of time before the country becomes a net oil importer. Rumor has it that that could happen as early as 2030.

That, dear reader, is the beginning of the end for OPEC.

Considering Saudi Arabia’s output of approximately 9.7 million barrels per day, that means the country’s daily consumption of 2.7 million barrels per day accounts for nearly 28% of its overall production.

But let’s get back to the recent supply cut. Since we’re not talking about a production cut, we have to believe that extra 300,000+ barrels is going somewhere.

Don’t worry, it is. The supply was routed into Saudi refineries due to increased demand. I know we’ve been hearing for years that King Saud is building up the country’s solar and nuclear capacity. But he isn’t a fool — he’s been building up the country’s refining capacity recently too.

Again, BP’s report showed an 18.9% year-over-year increase in Saudi Arabia’s refining capacity in 2013, which stood at 2.5 million barrels per day at the end of the year.

That leaves us with the current price environment, which has sent panicked investors rushing for the exit.

So why should we still look to oil over the long term? I think the Saudi petrochemicals chief nailed it: Prices will rise in the long term.

Yesterday, the price of WTI dropped below $80 per barrel for the first time since mid-2012. Even then, it was only for a brief stint, as it climbed back over $110 per barrel over the following 12 months.

For us, it’s impossible not to bet on U.S. oil. Independent drillers here are able to adjust to a low price environment. Don’t forget that virtually all of the United States’ production increase is coming from companies developing our tight oil resources. Production outside of those plays is still locked in a multi-decade decline.

And when we hit the bottom of this bear market, there will be an unprecedented buying opportunity in U.S. drillers that have been unfairly beaten down…

Until next time,

Keith Kohl

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A true insider in the technology and energy markets, Keith’s research has helped everyday investors capitalize from the rapid adoption of new technology trends and energy transitions. Keith connects with hundreds of thousands of readers as the Managing Editor of Energy & Capital, as well as the investment director of Angel Publishing’s Energy Investor and Technology and Opportunity.

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