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Stewart Dalby: Is the Saudi war on frackers working?

Stewart Dalby: Is the Saudi war on frackers working?
Is the sun setting on the Saudi-led OPEC cartel?

Saudi Arabia, the leading light of the Organisation of the Petroleum Exporting Countries (OPEC), will not be ending its price war against US frackers any time soon.

That is official. The editor of the Financial Times, Lionel Barber, has been in Riyadh, the Saudi capital. Together with his colleagues he was told by senior officials that the Kingdom, the world’s largest oil exporter, is determined to protect its market share despite the financial pain the price war is inflicting on the economy.

“The only thing to do now is let the market do its job,” said Khalid al-Falih, chairman of the state-owned Saudi Arabian Oil Company (Saudi Aramco),

“There have been no conversations here that say we should cut production now that we’ve seen the pain.”

Other officials told the FT journalists that their policy will be vindicated in one to two years’ time when revived demand swallows the global oil glut and prices begin to recover to the US$70 to US$80 a barrel level. 

Saudi Arabia rocked oil markets last November when OPEC decided against production cuts, making clear that the Kingdom was abandoning its traditional policy of reducing supplies to stabilise prices.  Since then the oil price has collapsed from a high of US$115 a barrel to around US$40 a barrel.

Specifically, the Saudis actions were aimed at putting high-cost shale oil and gas frackers in the US out of business, thereby reducing US output and leaving countries like Saudi Arabia to maintain their high level of exports to the US.

While US production has fallen somewhat -- having soared to something like Saudi Arabia’s current  levels (10.6mln barrels a day) -- some commentators believe  the Kingdom’s strategy is already being seen to fail and the Saudis are fooling themselves if they think they can continue with low prices for another two years .

Certainly the pain the Saudis say they feel is real enough. The Saudis said they would use their substantial foreign reserves to finance the production increases. But the reserves appear to be sinking as fast as the oil price.

Last year they were US$737bn and fell to a three-year low of US$647bn in September. According to the International Monetary Fund (IMF) the Kingdom’s budget deficit will reach 20% of GDP this year, or roughly US$140bn.

The Saudis have just announced they are tapping international bond markets for the first time, another sign of the damage that lower oil prices are having on their public finances.

One commentator who has been saying for the past few months that the Saudi strategy is not working is Ambrose Evans-Pritchard of the Daily Telegraph.

He has written if the aim was to choke the US shale industry, the Saudis have misjudged badly.

Okay, Wood Mackenzie estimates the major oil and gas companies have shelved 46 large projects, deferring US$200bn of investments.

But the problem now for the Saudis is that the US shale frackers are no longer high-cost. They are now mostly mid-cost. As oil prices have fallen so has the price of rig hire. Technological innovations have also reduced costs.

Evans-Pritchard said John Hess, the head of Hess Corporation, a fracking group, told him: “We’ve driven down drilling costs by 50%, and we can see another 30% ahead.”

In a recent article Evans-Pritchard concluded: “Until now shale drillers have been cushioned by hedging contracts. The stress test will come over coming months as these expire.

“But even if scores of over-leveraged wild-catters go bankrupt as funding dries up, it will not do OPEC any good. The wells will still be there. The technology and infrastructure will still be there. Stronger companies will mop up on the cheap, taking over the operations.”

Evans-Pritchard could be wrong in his belief that the Saudis will end their price war sooner rather than later without having achieved their goal of choking the US frackers.

But there is one thing he is surely right about and that is, after all the pain their price war has caused, Saudi-led OPEC will no longer be the major force in determining what the oil price will be.

Evans-Pritchard, quoting a Bank of America spokesman, said OPEC is “effectively dissolved”. If this is the case, the cartel might just as well shut down its offices in Vienna to save money. 


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