This Is the New Saudi Normal

This Is the New Saudi Normal

by | published July 12th, 2019

It has been rolled out by the Saudis.

According to my sources, a new approach was spelled out at the OPEC meeting in Vienna earlier this month. The organization announced on July 1 that it was extending its OPEC+ (OPEC plus Russia) agreement to keep 1.2 million barrels a day in production cuts for at least the next nine months.

Pundits immediately fixated on the two most obvious aspects of the move.

First, the internal consensus within OPEC, including an agreement between Saudi Arabia and Iran, was unanimous in maintaining the cuts.

Second, President Trump back in Washington had been rebuffed – Trump has been clamoring for additional OPEC production to restrain prices of finished oil products (like gasoline and, to a lesser extent, low sulfur content heating oil and diesel).

Last fall, Trump goaded OPEC members into increasing production pledging to apply oil export sanctions against Iran in the first week of November. However, after securing the increase, Washington then provided 180-day exemptions to the eight largest importers of Iranian crude, assuring a glut in the global market that depressed prices over 40% (just in time for the U.S. off year election).

After having thus been played politically last year, nobody in Vienna was reading the executive tweets this time around.

The other element here is that OPEC members, and other produces such as Russia, Kazakhstan, and even Mexico, are now making decisions based on their own interests not those of the U.S.

The implications are as follows…

The End of American Influence

Until a few years ago, Washington’s ability to influence oil prices was largely determined by import policy; OPEC had regularly relied upon American end users to provide a reliable market for members’ oil exports.

In turn, that (along with the trade being denominated in dollars) provided some leverage for the U.S. in dealing with the cartel.

But that has ended.

U.S. imports from OPEC have declined significantly. They could reach zero if not for American refineries increasing margins by receiving some OPEC production, and then exporting the products distilled from it.

The game changer, of course, has been the incredible largesse in domestic volume resulting from the shale revolution, which brings us back full circle to the important Saudi change telegraphed to me last week in London.

The Saudis have revised their approach to something that now bases production levels on the supply produced in the U.S.

The Saudi Position Has Changed

We need to pause a little and take in what this revision means: a fundamental shift in Saudi thinking.

Back on Thanksgiving Day 2014, Riyadh led OPEC members into a strategy of defending market share rather than price. That ended up with a cataclysmic slide in prices to below $30 a barrel, as increasing production was injected into an already saturated market.

One of the main objects then is the same now – U.S. shale (and tight) oil volume. In its wake, the decision to defend market share resulted in a major negative pressure on U.S. producers between 2015 and 2017. This resulted in a huge spike in interest rates for essential crude life lines (most American producers operate cash poor) along with the most pronounced bankruptcy and merger an acquisition cycle in decades.

Yet, on balance, the U.S. oil patch survived and is now producing in excess of 12 million barrels a day.

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The ceiling on how much of that can be exported into the global market – and in direct competition with high sulfur content crude from the Saudis and other OPEC countries – is currently determined by American port and infrastructure capacity.

But that is about to change as dredging and construction operations are completed further own the coast from Houston and the Channel, especially in the Corpus Christi area.

That means the competition will intensify moving forward.

And as a result, the Saudi position has changed.

We Now Have The “Call on Shale”

Riyadh regards the life span of primary U.S. shale production to be far more limited than the more conventional reserves held in Saudi Arabia. As such, the broader approach is now to play the long game.

As Saudi Energy Minister Khalid al-Falih said after the conclusion of the OPEC meeting that shale would eventually go the same way as every other oil basin in history. “It will peak, plateau and then decline.” The minister then added: “Until it does, I think it is prudent…to keep adjusting to it.”

These adjustments will not be without limit, al-Falih continued, noting the Saudis would not be prepared to remain as the market balancer if that meant cutting production too far. As the minister put it:

“Even with U.S. growing at fantastic numbers over the last couple of years certainly in 2018 and 2017, we’ve been able to grow. Look at Russian production, it has grown. Not too long ago, three or four years ago, Saudi production was in the low nines [nine million barrels day]. And we thought we were going to be stuck in that neighborhood for a long, long time. And here we are today talking about climbing down from 11.1 to 10.3….If we find out that we’re having to cut unreasonably, then that’s when we’ll say we can’t do it anymore. So if you told me today that you have to go back to 8 million to balance the market, Saudi Arabia, I would tell you no. That is a structural change that Saudi Arabia will not do. We will not cut to allow shale to grow 2 -3 million year after year after year. That is a structural change Saudi Arabia cannot do.”

The import from these comments is rather clear.

If the balancing requires further cuts, this will be hammered out within OPEC and between the organization and major outside producers like Russia.

Saudi Arabia, however, does not believe that will be a problem, given the continuing draw down in production from Venezuela, Libya, and Nigeria inside OPEC combined with indications that internal U.S. market factors dynamics will cap shale production with their own competition dynamics.

The takeaway is encouraging for energy investors.

Short of outlier pressures (renegade production, wars, or Mother Nature), this new Saudi approach will provide a floor for oil prices.

While there will be occasional dips in that price, we are not likely to witness a major drop. Overproduction will be dealt with by the barometer of what comes out of the ground in the U.S.

Traditionally, OPEC has calculated the expected monthly worldwide oil demand, deducted non-OPEC production, and determined what is called “the Call on OPEC” with that figure then divided among organization members. The call became the basis for anticipated supply in the global oil market.

Not anymore. What I had prophesized several years ago here in Oil & Energy Investor is coming to pass.

The Call on OPEC is giving way to the Call on Shale.



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