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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