Saudi Arabia Did Not Have a Choice

abarrelfullabarrelfull wrote on 03 Dec 2014 10:45
Tags: opec prices upstream

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Much has been written about the decision of OPEC not to cut its production, taken at the 166th Meeting held last week.

By the time the meeting was held, most market players had come to the conclusion that there would be no change, but even the small remaining hopes of positive language were shattered. Oil prices fell further and are languishing at levels many thought impossibly low just two years ago.

Not so long ago, the consensus was that Saudi Arabia, the driving force behind OPEC decisions, needed $90 dollars a barrel to balance its budget, and so would defend that price.

That proved to be false.

So what was it that drove the decision, and what can we expect for the future?

  1. Firstly, I don't think that the Saudis had much choice. There have been very big increases in supply and stagnant growth. The amount that would have to be cut in the short term to defend $90 per barrel would probably need to be bigger than acceptable
  2. A cut of even a million barrels per day may not have worked, and OPEC would have been exposed as a paper tiger
  3. If it worked in the short term, US tight oil production would have continued to rise, gradually nullifying the impact
  4. The impact of low oil prices hurts others much more that the Gulf States
    • Venezuela, a regular cheater, is in big trouble and will see its production shrink as it cannot invest
    • Iran, the Gulf States number one enemy is already hurting from sanctions and may be forced to a decision on their nuclear programme, which interests the Saudis even more than it does the Israelis
    • Russia was already in trouble, as mature fields decline and massive investments are needed in their replacements. The political environment has made this a challenge. Sanctions have made this even more difficult, as Russian companies struggle with financing. Now low oil prices have made it impossible. This story is one small example of the problems.
    • In general, new projects need huge investments. Low oil prices are forcing companies everywhere to postpone projects

So over the medium term, we can expect to see investments fall and therefore the global production capacity will decrease. Don't forget that production from mature fields declines at a significant rate, and most investment only replaces production, it doesn't increase it.

I don't think that US tight oil is the issue. The business well established, infrastructure is in place or being built, and experience has been gained. Low prices will hurt production, but that can quickly come back on again. It will however slow down new developments elsewhere, which is an important target for OPEC

Even a few months of prices at this level will create a level of uncertainty that will impact investment decisions over the next few years. Given that heavy crude and deep water developments are a major part of the investment portfolio, this will prove to be evr more significant as time goes by.

So what does OPEC do next?

If the oil price stabilises at today's level, a small cut in 6 months time might increase prices enough to give a decent boost to revenues without taking them high enough to spur investment. It would certainly work better than a cut today, which probably would have achieved nothing


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