Oil price war: Saudis take fight to US turf

Saudi Arabia has launched a third-wave attack in its oil price war this time targeting the US shale oil producer. OPEC’s largest oil producer had just announced that they were cutting oil prices for customers in the United States. The idea is to squeeze margins on US shale production to where it is not profitable to produce.

It has been a treble hit of arsenals from Saudis. First they cut prices, then they refused to cut production, and now they cut prices again. Saudi Aramco, the state owned oil company, showed no sign of retreat and cut its price on its Arab light to a record low $2.00 discount to the local benchmark for customers in Asia and prices for all grades of crude to US refineries.

It is no longer a secret that the Saudis are determined to defend their market share, whatever the cost may be; they will cut prices in Asia, they will cut prices in Europe, they will cut prices in the US. Their economic existence may come down to winning this price war.

The ban on oil exports from the days of the oil embargo may fall as the US looks for a way to respond to the actions of Saudi Arabia. Lifting the ban would allow US oil producers to sell oil in global markets where they can command a higher price.

The Saudis are losing control over oil pricing power they have held for decades. It is annoying them to no end so, they are fighting back the only way they know how in an attempt to shift the balance back in their favor – by starting a price war with the United States.

It costs Saudi Arabia only about $2 a barrel to get crude out of the ground. But analysts insist the Saudis’ real pain point is more than $100 a barrel because data point from the IMF estimates that Saudi Arabia needs oil prices to average $89/barrel to balance their budget. Essentially, that means the Saudis are punishing themselves. The country cannot withstand a long-term drain on its finances. In 2010, for example, the Saudis spent $130 billion to combat the Arab Spring; there was a 15 percent raise for government employees, higher unemployment benefits, a government-subsidized minimum wage hike and 500,000 new homes in a nation of 28 million people. It cost 30 percent of Saudi gross domestic product.

Can Saudi win this war?

The Saudis deny the notion that there is a price war but it is rocket science to read between the lines and know Saudis have declared a full blown oil price war.

In the late 1980s, the Saudis brought the rest of the world to its oil pricing knees by increasing output and lowering prices to the point where global producer profitability got crushed. They dropped prices so low that even North Sea producers like BP and Statoil ASA felt their wrath. Profitability vanished because nobody in the global energy complex had enough capacity to offset their actions.

However, the dynamics have changed over the years. What worked years before may not worked this time around as a lot of market dynamics have been altered. This time around, there is shale oil. US now have 36.5 billion barrels of proven oil reserves according to the Energy Information Administration (EIA). This is a 9.4 percent increase and the most amount of oil US have had since 1975. Technology in the US will continue to allow them to expand the amount of oil that can feasibly get out of the ground. The more the Saudis posture, the faster US producers will react.

Some analysts believe that the Saudis have just made the biggest strategic “pricing error” in the kingdom’s history. And, in doing so, they have actually cleared the way for America’s shale energy boom.

Saudis have totally underestimated the impact of shale. They believe that US producers will fail if they jack output and drop prices below $90/barrel. In 2012, when U.S. shale burst into public consciousness, estimates were that it would cost at least $70 to $75 a barrel to produce.

What they are missing is that the cost of shale oil production is getting lower every day. Latest data from US producers suggests that they can operate profitably at $65-$69/barrel and that the threshold will keep dropping as production technology improves. Even $30 may not be out of the question. Data from the state of North Dakota says the average cost per barrel in America’s top oil-producing state is only $42 to make a 10 percent return for rig owners. In McKenzie County, which boasts 72 of the state’s 188 oil rigs, the average production cost is just $30, the state says. Another 27 rigs are around $29. One of the reasons being that the majority of US shale oil producers have hedged oil prices, already contracted rigs, and long ago written down the cost of the acreage they need to drill.

Frank Uzuegbunam