Saudi Arabia's $750 Billion Bet Drives Brent Oil Below $54
With Brent crude oil falling on Monday below $54 a barrel for the first time in more than five years, it is clear that Saudi Arabia is making a massive $750 billion bet in 2015 that the oil kingdom can endure lower oil prices longer than other major oil producing countries both within and outside OPEC, even including American shale.
A flood of new oil from U.S. shale producers and Canadian tar sands companies coupled with softening demand from China may have set the stage, but Saudi Arabia is now firmly driving the process that has seen oil prices plunge in a matter of months. Starting in October, Saudi Arabia indicated to global markets that it would not materially cut production alone and would restrain itself from cutting production unless other major oil producing countries also joined in such an effort.
“The most important thing for the Saudis is market share,” says Prof. F. Gregory Gause, a Saudi expert at Texas A&M University. “They are not going to sacrifice it, they will play chicken with other producers, whether Iranian or American shale producers, in order not to lose market share and the only way they will cut production is if they get an agreement with a broad array of OPEC and non-OPEC producers to take a fair amount of oil off the market.”
Saudi Arabia’s move is inflicting pain on the energy-based economics of countries like Iran and Russia, and big national oil companies ranging from Russia’s Rosneft to Brazil’s Petrobras , which saw its shares fall another 8.4% on Monday. Big U.S. shale producers saw their shares take another hit on Monday. Shares of Continental Resources CLR -3.49%, for example, fell by 12%. Companies engaged in offshore drilling also got hit, like Transocean , whose stock fell by another 7% on Monday. Transocean’s stock has plunged by 65% in the last year.
The decision by Saudi Arabia, the world’s biggest oil exporter, not to cut oil production and play the role of swing producer to stabilize oil prices is also costing the oil kingdom. Saudi Arabia recently released a 2015 budget showing a $38.6 billion deficit, its largest ever, projecting a significant decrease in oil-generated revenue. But Saudi Arabia has accumulated $750 billion in foreign currency reserves and has signaled it is willing to spend its cash hoard and put it on the line in this global oil battle.
Saudi behavior in the global oil market is informed by the oil kingdom’s experience in the 1980s, when oil prices collapsed below $10 a barrel. At the time, the Saudis kept cutting production and losing market share because other OPEC members continued to pump out as much oil as they could. This time around, the Saudis not only need to get other OPEC members in-line on production cuts, but also non-OPEC members like Russia and Mexico. In the case of American shale, there is no single policy maker, but hundreds of independent oil companies making up a market that Saudi Arabia can try to influence by making future investment seem riskier and unprofitable.
“The Saudis are putting the heat on everybody and you don’t need to parse it out and say they are really putting the heat on Iran or they are really putting the heat on shale or Russia,” says Gause. “They have decided that given the current market situation they are not going to cut until others cut and all sorts of players are going to feel the sting on that.”
Still, the key for the Saudis could be Vladimir Putin and Russia. The Wall Street Journal did some very interesting reporting right before the end of the year, showing the efforts that Saudi Arabia recently made to get non-OPEC producers like Russia to cooperate in oil production cuts. Saudi Oil Minister Ali al-Naimi tried to get Russia to agree to production cuts in late November, but Russia made it clear it was unwilling to do so, The Wall Street Journal reported. “Russia is the hardest nut to crack,” says Gause.
Oil traders say they believe that Russia, which is facing economic pressures stemming from Western sanctions in addition to plunging oil prices, would find it very hard to stomach production cuts at this time, but that maybe the Saudis could force Russia to decrease future investment.
On the surface, it seems lower prices might be around for a while.