Saudi Oil

The FT’s lead article yesterday is a misinterpretation of the position, in my view.

“Saudi Arabia claims it has the upper hand in the battle for oil dominance. One of its officials told the FT its strategy of squeezing high-cost rivals by boosting production in order to lower prices is paying off: "There is no doubt about it, the price fall of the last several months has deterred investors away from expensive oil including US shale, deep offshore and heavy oils".

This is consistent with current views from a number of the sell-side commentators. Having generally failed to spot the halving of the oil price, some of the big banks are now saying that the Saudis have been really astute and are protecting their medium term market share.

What has Saudi really achieved?

  1. A drastic cut in their income and the income of all their fellow cartel members.
  2. So painful has this process been for some of their colleague members, that their response has been to increase output, further pressuring the Saudi share of the market.
  3. Meanwhile, the rig count in Saudi has sharply increased. This is hardly the action of a relaxed producer with plenty of spare capacity and the ability to flex output significantly. Rather, it is supportive of the theory that the Saudis have limited capacity to act as swing producer and in fact are under pressure to maintain output. The data could be misleading of course, but it might be representative.
  4. A 20% or more improvement in the cost base of their principal competitor. Far from significantly weakening shale producers, the US industry has reacted quickly and positively. The service providers have slashed prices and are seeking efficiency improvements. There have already been some initial consolidation moves among shale producers, and more are likely. The remaining US shale players will emerge from this period larger and financially stronger.

With intense competition in the US services market, and significant excess capacity in fracking etc as the rig count has tumbled, it’s likely that the US shale players have seen a greater reduction in services prices than their Middle Eastern counterparts, hence improving their relative competitive position.  I believe this will improve further as they industrialise the process of shale oil extraction.

I have no idea what the Saudi long term game plan really is. I think the oil price outlook medium term is positive, although I suspect that the recent strength will fade. I remain long the oil sector, in producers rather than service plays.