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Crude Economics
Why the Saudis Aren’t Cutting Production

With oil trading at less than half of what it was last June, plenty of market observers have been surprised by OPEC’s decision not to scale back output to set a floor to the price. One compelling reason is that the cartel’s largest member is well prepared to ride out this bear market. The EIA reports:

In addition to having the second-largest proved oil reserves—268 billion barrels, or 16%, of the world total in 2014, behind only Venezuela’s 298 billion barrels—Saudi Arabia has a massive sovereign wealth fund (SWF) that will enable it to weather lower oil prices. To maintain spending at the same level as in the past, Saudi Arabia would need to tap its SWF, which currently has $733 billion, or about 19 times its expected 2015 budget shortfall of $39 billion. Consequently, the short-term effect of lower oil prices on Saudi Arabia should be minimal. In contrast, OPEC’s decision to keep crude oil production near present levels, keeping supply high and prices low, has affected the budgets of members that lack Saudi Arabia’s financial reserves.

At current oil prices, the Saudis can only muster up funds for some 83 percent of their total budget. The expected $39 billion budget deficit will be paid off from the Saudi sovereign wealth fund, which today is worth more than $730 billion. In other words, at current budget levels and oil prices the Saudis could continue as is for another two decades before nearing the prospect of default.

OPEC hasn’t cut production in the face of plunging oil prices because the Saudis have decided to compete for market share rather than induce a price rebound. The above numbers tell us why Riyadh has been so seemingly fearless in that quest to squeeze U.S. shale producers. But while the Saudis comfortably weather the storm, other OPEC members, like Venezuela and Iran (which run budget deficits when the price of oil drops below $123 and $140 per barrel, respectively) are having a tougher time adjusting.

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  • Jacksonian_Libertarian

    “The expected $39 billion budget deficit will be paid off from the Saudi sovereign wealth fund, which today is worth more than $730 billion. In other words, at current budget levels and oil prices the Saudis could continue as is for another two decades before nearing the prospect of default.”

    You are mistaken, the price for Arabian oil didn’t drop until the end of last year, so while they may have suffered a budget deficit of $39 billion, that was accrued in only the last 3 months. In other words, they lost an average of $40 billion in 3 months as the price fell from $100 per barrel to $50 per barrel, or had the price been all year what it is today, they would have lost $160 – $200 billion (maybe more as we don’t know how they did their accounting, how did they account for the surplus they had for the first 9 months of the year?), which is what they are going to lose this year. At that rate they will easily eat through their savings in 3-4 years if they don’t start cutting their budget.

    • Johnathan Swift Jr.

      It always nice when someone actually takes the time to question the math quoted in articles and online posts. I suspect that many writers are typical liberal arts majors and aren’t capable or even interested in checking these calculations they quote. Its the same thing for surveys, which, when quoted, should as a manner of factuality state the number of people surveyed, the refusal rate and the specific (often loaded) questions so that readers can determine whether to take it seriously. This has always been one of my major issues with the global warming scenarios. When you read the Climategate e-mails you see these climatologists are not only writing their own computer programs, but working with statistical calculations, neither of which they seem to have mastered and of course the fate of the world’s economy depends on their “models.” So, thanks for checking!

    • Andrew Allison

      The budget shortfall referred to is the estimate for all of 2015, not last year. Who knows what price the Saudis used in calculating the shortfall, but keep in mind that the low price only applies to US deliveries. Whilst this might lead one to believe that US tight oil producers are the target, I suspect that the Saudis know perfectly well that US tight oil production costs are close to the current price, and the strategy is something else.

      • William Ockham

        In his prior comment Andrew Allison states that Iran needs $130 to $140 to break even on it’s budget. Does anyone know how much Iran has in it’s reserves. If so we can calculate their drop deed date. Do we know Russia’s break even point and the amount of their reserves so as to make a like calculation. If either of their drop dead dates are in the next few years, this is a death warrant. What other strategy is there for Iran, perhaps in conjunction with Russia, than to strike across across the gulf to destroy Saudi Arabia and it’s oil industry.

    • William Ockham

      This is very important. Do you citations or other sources to support your contentions. Thanks

  • Nathaniel Greene

    The real loser in the Saudi decision to maintain production is OPEC, not US shale producers. US shale producers are well positioned to maintain market share. Some marginal producers will be forced out but US oil production will continue to increase as it has since the market collapsed. Natural gas is extremely cheap and is taking over more and more share of the US energy market, still further decreasing the need for imported oil.
    Saudi Arabia can maintain its market share in Asia thus squeezing out its OPEC colleagues. Poor Venezuela, it will be the biggest loser. It needs the US market to generate cash flow and to buy its very heavy crude. Having the world’s largest oil reserves is meaningless if there is no market for your oil and you don’t have the cash to extract it anyway.

    • Johnathan Swift Jr.

      Every time I read about miserable Venezuela I think of the little book “The Memoirs of a Perfect Latin American Idiot,” which is a book about Central and South America’s love affair with the far left, which never seems to end, even when they make the Norway of South America, which should be awash in cash, a poverty-stricken hell hole with Soviet style lines and rationing!

  • douginsd

    it’s also way cheaper for the Saudis to do this than to try to get in an arms and foreign aid $$ influence race with their main adversaries, Iran and Russia. They are killing multiple birds with one stone.

    • Johnathan Swift Jr.

      This is it seems their long game. They were only in OPEC because it once benefitted them. Now that it no longer does and the other major players are in free fall, they can cut it loose.

      The irony that I see is that now that the United States has real bargaining power with 1) Iran 2)Russia 3) Venezuela and 4) Cuba, which has been propped up in part by the Chavistas, he is out to sign agreements with them and get nothing in return. He is the worst negotiator in recent history, but that is assuming he is on our side, which one must doubt. The recent deal with Cuba is one that seems to be a lifeline, opening it up to Americans seems, by design, to prop up the Castros, not to force them to liberalize! The same thing with Iran. When your enemy is on the brink of collapse, the last thing you want to do is to send them a lifeline.

    • Reticuli

      Educating and arming terrorists is far cheaper than the cartel driving the price of gas down. They’re doing this because of the threat of methanol. They are trying to drag out their oil economy for as long as they can prior to being force into one based on innovation, education, and creating, which interestingly will also have less income & power disparity in The Kingdom than their current system of people (mostly Pakistani labor) & resource exploitation (the oil).

  • Allan Theobald

    Exactly how long the Saudi sovereign wealth fund will last misses the larger point that they have nothing else to generate income. One day soon they will return to being a small desert country of only minor significance.

    • douginsd

      Yes, but that may take a couple of hundred years. Meanwhile, a vast swath of the world will have a plurality of Muslims who have been Wahhabified.

      • Johnathan Swift Jr.

        Yes, it seems that they have used their oil revenues to spread their own noxious version of Islamic supremacism throughout the world, to radicalize large swaths of the Sunni world. Meanwhile, we have the world’s left in common cause with them, making excuses for them, blaming it all on our foreign policy or Danish cartoons or the excuse of the week. Meanshile, the radicals are attacking all over the world. I always ask the apologists, “what about Thailand?” It has no history of Colonialism and isn’t invading Islamic lands, but has suffered thousands of attacks over the past fifteen or twenty years, not because of what the Thais have done, but because the radical strains of Islam and Islamism are on the march.

      • Allan Theobald

        Nonsense they are already greatly diminished and will become an afterthought in a decade.

  • Gene

    If, as we’ve been told so many times, the Saudis see Iran as an existential threat, the greatest benefit of this from their standpoint is the hurt it puts on the Ayatollahs.

    • mattman26

      Yes, exactly. I’ve read (WSJ) that the Iranians need oil in the $80+ range just to keep their heads above water.

      Couldn’t happen to nicer guys.

      • Andrew Allison

        It’s considerably higher than that — $130-$140 according to most estimates.

  • Daryl Montgomery

    Saudi numbers seem to be what would be generated by using common core math. There is an implicit assumption that they have an unlimited amount of oil that will last forever. The oil reserve figures from OPEC countries are laughably high. Quota was set based on reserves and once that policy was instituted, reserves magically went up in every country even though there were no new discoveries. The Saudi’s largest field (and the largest in the world) Ghawar has been producing since 1951, or for 64 years — ancient for an oil field. They started using water injection to create added pressure to get the oil out in the late 1960’s, well over 50 years ago. They have instituted new technology in the last few year and this is allowing the Saudis to produce more oil now than they did when oil sold at close to $150 a barrel in 2008. This doesn’t mean they will be producing more oil in total, they are just getting it out of the ground faster (and selling it at cheap prices). By doing so, they are risking well collapse — a sudden, drastic and permanent drop in production. More likely, something similar to what happened to the Mexican Cantarell field could take place. At U.S. suggestion, the Mexicans utilized technology to pump the oil out faster. Cantarell, which was the 2nd largest producing field in the world in 2004 (2+ million barrels per day), entered a rapid decline shortly thereafter. It now produces below 400,000 a barrels per day and is still falling.

    As for those supposedly “huge” Saudi financial reserves. They’re going to need them. The country is a massive welfare state funded by oil PROFITS. They need substantial PROFITS to fund their ongoing day-to-day operations. Any decline in funding is potentially dangerous in a volatile and political unstable country, so the risk is high for them. Projected Saudi profits are less than is believed in the West, because their cost of producing their oil is much higher than believed. I have seen figures as low as $3 listed. This was true in the past, but probably hasn’t been since the 1970s. If it is necessary to use substantial water pressure to get oil out of the ground, which the Saudis have done for decades at this point, their productions costs aren’t very cheap anymore.

    How much are Saudi profits reduced by their current over pumping of oil? For simplification, let’s say oil was $100 (actually it was higher) and the Saudis were selling 9 million barrels per day and now oil is at $50 (it’s been lower), but the Saudis are selling 10.5 million barrels a day. So they had $900 million in daily revenue, but now have $525 million a day in revenue. So that means the Saudis are receiving $375 million less PER DAY in revenue. That would equal their claimed reserve level in a little over 5 years, assuming nothing goes wrong with those reserves, like a 2008 financial failure for instance, and they don’t develop a significant decline in their oil production (which is past its Hubble peak). Can the Saudis run their reserves down to zero or even anywhere near zero? No, not at all. They might need that money to buy luxuries like food and water in the future for their rapidly increasing population.

    • Johnathan Swift Jr.

      I guess this is why the Saudi’s always want things to be opaque, so that no one really knows exactly what is going on behind the screen. They have a very restive population and are sitting on a powder keg, which at some point must go off, so one would think the more diversification of energy sources we have, the better off, the more stable things will be. I would think a shift to natural gas for automobiles, at least many more bus and truck fleets, if not passenger cars, would be a good idea, but I am not an energy specialist nor do I play one on television.

  • FriendlyGoat

    The fewer the number of dollars flowing into Islam from the western world, the better, right? This is, however, the reason why we will probably see oil drifting back up over time. Saudi Arabia can ignore reduced revenues longer than any other petro-states, but they’e not going to want to do it forever.

  • Reticuli

    The cartel is attempting to dissuade the adoption of a G.E.M. flex mandate on new cars by keeping the price of gasoline in the USA around $2/gal, which is the current price of methanol at its current admittedly modest scales prior to a demand-side fuel-choice mandate. The Saudis know the jig is up and are trying to drag out their profits for as long as possible. We have better reasons to mandate flex choice than just cost savings: Terror, poverty, environment, political & economic independence, etc.

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