Did the Saudi Oil Coup Manage to Sideline U.S. Shale?
Having somewhat belatedly woken up to the realization that to do otherwise might very well sound the death knell for its own faltering economy, Saudi Arabia has finally signaled an end to its aggressive two-year oil price war.
Back in 2014, the kingdom decided to hike supply in a bid to drive out its high-price rivals, abandoning its traditional balancing role in crude oil markets. The move, which saw the price of oil fall from over $100 a barrel to around $26, was primarily driven by fears that U.S. shale drilling operations posed a risk of grabbing considerable market share from OPEC producing nations.
As recently as February, Saudi’s then petroleum minister Ali al-Naimi told American frackers they would be crushed by the plummeting price of oil, which his country was continuing to pressure downwards by churning out a large oversupply. In April, the Kingdom even boasted that it could raise output by more than a million barrels a day almost overnight if there was demand for it. The Deputy Crown Prince argued that the Kingdom could even hit 20 million barrels a day (bpb), up from current levels of 10.2 million, if it chose to invest in its oil industry.
Just two months later, Riyadh was striking a far more conciliatory tone. Towards the end of June, Saudi Arabia's new energy minister Khalid Al-Falih told the Houston Chronicle the kingdom was effectively throwing in the towel. He said overproduction had been halted, and that the country was working its way through an “overhang of inventory.”
Al-Falih’s assurances last week prompted U.S. energy secretary Ernest Moniz to voice his confidence that oil markets would now slowly come into balance as demand gradually started to level with supply. Moniz told reporters that while the effects of Saudi cutting production might not be seen until well into next year, prices could head towards $70 a barrel, resulting in U.S. producers adding additional wells.
So, what caused Saudi’s apparent abrupt change of heart? It is true that the kingdom’s assault on oil prices has caused considerable pain for U.S. producers, but it has far from crushed them. While U.S. oil-rig counts were recently around 50% down from their 2015 peak when Saudi started its campaign of oversupply, American producers are by no means out for the count.
The reason why the kingdom backtracked on its 20 million bpd promise is because Riyadh is facing an existential economic crisis, fueled by a massive budget deficit and soaring unemployment. It knows that it needs to rebalance its flailing economy away from energy, but now acknowledges that short to medium-term healthy oil rents are a key factor in its transformation.
The country is pinning its turnaround hopes on Deputy Crown Prince Mohammed Bin Salman’s ambitious “Vision 2030” reform plans, which include a program of continued austerity, a large-scale sell-off of state assets, the shrinking of the Saudi public sector, and a push to boost foreign investment with a view to establishing the world’s largest sovereign wealth fund. The centerpiece of the prince’s proposals is the privatization of Aramco, the Saudi government’s oil and gas producing enterprise.
Accepting that all of this will take no small amount of time, Riyadh has conceded that it can ill afford to engage in an ongoing battle with its energy-producing rivals at a time when it needs higher oil revenues to sustain it through this monumental period of change. Not only will higher oil prices cushion the country through its ongoing and lengthy readjustment - providing much need funds to boost government coffers through the rest of its belt-tightening program - they will also boost the potential value of Aramco when it is finally offered for sale. Saudi is additionally well aware of the fact that playing ball with the U.S. on oil may well ease the flow of American investment into its economy over the longer term. In short, Prince Mohammed’s program of reforms has much less of a chance of succeeding while the price of oil is low.
The deputy crown prince was in the US recently to drum up interest in his country as an investment destination, while British and European banks are looking at Saudi state asset selloffs as major opportunities to work on deals. The Prince is also hoping to spark the interest of British investors, who operate more than 6000 companies in the Kingdom, worth around $16 billion. With the economy opening up, Riyadh has accepted that stable oil rents are perhaps more important to its economy that those of its rivals, who on a macro level appear to have been only partially inconvenienced by its efforts push them out of the oil market.
Riyadh’s efforts to break its oil-producing rivals have also dragged down the whole of OPEC’s collective revenue. According to its annual statistical statement, the 13-nation bloc’s members ran a combined deficit of $99.6 billion in 2015, compared with a surplus of $238.1 billion in 2014. While failing to break the U.S. fracking industry, Saudi’s oil price war ended up doing it and its closest economic allies just as much harm as its rivals.
As such, oil prices could likely dip to as low as $30 a barrel before they rally as Saudi works through its remaining inventory, along with other oil-producing nations that have built up a glut of supplies during the years of overproduction. Even so, the nosedive in oil prices appears to have had little lasting effect on the U.S. shale drilling industry, which is currently facing more pressing concerns from presidential candidates on both sides of the political divide who have proposed policies that might pose a greater threat to its existence than Saudi could ever hope to inflict.