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Crude Economics
Petrostates Wince at Oil Price Pinch

The precipitous fall of the price of oil took most by surprise, and it’s produced both winners (namely buyers of crude) and losers (those who sell it). With its heavy reliance on oil production, the Gulf region is predictably feeling the pain of today’s bargain crude prices. The FT reports:

[G]overnments across the [Gulf] region have begun to trim spending and reschedule capital expenditure plans…Private sector companies are also grappling the same issue, which has had a marked impact on corporate valuations and hit the regional mergers and acquisitions market in particular. […]

“Governments are going ahead with key projects and completing existing contracts,” said one senior regional banker. “But other stuff is being pushed back — basically put on hold until the oil price recovers.” […]

While Saudi Arabia has ringfenced as much as $150bn for use in strategic infrastructure projects, Riyadh’s central bank reserves dropped by $20bn in February alone, the largest ever month-on-month decline — forcing it to dip into its $700bn-plus financial cushion to oil the wheels of government.

OPEC has so far chosen not to cut production, opting instead to weather lower prices in a bid for market share against new producers like those fracking American shale. That strategy is predicated on the idea that the world’s high-cost producers, which U.S. shale most certainly is, will be forced to cut production as their operations can no longer turn a profit in this bear market.

So the world’s petrostates are playing a game of chicken with our shale producers, and already it’s clear that the Gulf region is feeling the effects. Meanwhile, in the U.S., production growth is indeed slowing. However, operators are drilling but not yet fracking wells and putting crude into storage, waiting to start production and sell their product when the market rebounds. That means that if and when the global supply shrinks or demand booms anew and prices therefore rise, a new flood of American crude will be unleashed and the price, one would expect, would quickly come back down.

The current low prices present a major challenge to the fledgling U.S. shale industry, but firms are busy working on ways to reduce costs and in so doing are finding ways to make money in this buyer’s market. Meanwhile, so long as OPEC continues to sit pat, the petrostates of the world are left with only one option: to grit their teeth and cut spending.

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  • Kevin

    “Meanwhile, so long as OPEC continues to sit pat, the petrostates of the world are left with only one option: to grit their teeth and cut spending.”

    Actually they have at least one other option – use non-market means to reduce oil production by, for example, fomenting instability in other producer countries. Consider the case of Iran trying to destabilize Saudi Arabia – if there were significant unrest in Saudi Arabia’s Shiite majority Eastern Province, Saudi production would plumet and oil prices probably spike pretty soon thereafter.

    • Dan Greene

      Actually, if there were major unrest in Hasa, I think the Saudis would immediately put it down with ferocious brutality and the affect on Saudi production and oil prices would be short-lived.

      In any case, it’s not at all clear that the Saudi move is primarily directed at US shale rather than at Iran and Russia.

      • Andrew Allison

        Correct. TAI seems incapable of grasping the self-evident fact that the Saudis are playing “we’ll reduce production if-and-when you do” chicken with the other members of OPEC. They are perfectly well aware that US production is expected to increase for at least the next year and that, necessity being the mother of invention, shale production costs are declining rapidly. Besides which, production costs are completely irrelevant at the national level — it’s the amount of government revenue that comes from the sale of oil (negligible in the US) that matters. And, even if production levels of, US shale oil will put a cap on the price of oil sold in the US.

    • Pete

      Good point, Kevin

  • Jacksonian_Libertarian

    If the Oil Monopolies owned by the Government Monopolies think they’re going to be able to compete with the private companies exposed to the “Feedback of Competition”, they’re in for a rude awakening. It is the “Feedback of Competition” that forces continuous improvements in Quality, Service, and Price in free markets, and stagnate decaying monopolies have no chance of competing with free markets.

  • Jacksonian_Libertarian

    I would like to see a greater recognition of the importance of energy costs on modern civilization and how the falling costs will revitalize America. This is “The AMERICAN Interest” after all, a greater focus on the logistics of the American Hegemony would be welcome. The History of civilization has been a steady move from muscle power to other sources of power. And modern civilization is built on petroleum’s versatility as a portable high energy source of power.

  • fastrackn1

    Oil speculators have distorted the price of oil for so many years that I don’t think anyone knows where the price of oil should be these days. It was never worth $80 or $100+ per barrel in the first place. It just shot up about 10 years ago for no good reason and stayed high for no good reason….

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