Crude Economics
Saudis Race to Bottom of Oil Market

What do you do when the world is flooded with more crude than it knows what to do with? If you’re Saudi Arabia, you boost production and start selling your oil at a discount. Riyadh has strong-armed OPEC into a policy of inaction over the past year, choosing to endure low prices as the cartel competes for a share of a more competitive market rather than cutting production, as it has done in the past, to help set a price floor.

But the Saudis aren’t content to just go on with business as usual. As the WSJ reports, Saudi Aramco is actively looking to woo customers with discounts on already bargain-priced crude:

In a list of official prices sent to customers, state-oil company Saudi Aramco cut the price of its light-crude deliveries to Asia by $1.7 a barrel. As a result, it switched to a discount of $1.6 a barrel against the rival Dubai benchmark from a premium of 10 cents a barrel previously. The company also cut its prices for heavy oil by $2 a barrel to the Far East and by 30 cents a barrel to the U.S.

The move come as Iran, Iraq and other countries in the Middie East made deeper cuts in their official prices than Saudi Arabia last month.

It’s a race to the bottom, it seems, as the world’s petrostates look to outdo one another in their attempts to cling to their market position. Though U.S. shale—one of the precipitating causes of the 2014-15 price crash—has shown signs of slowing, it hasn’t crashed in the manner the Saudis expected when they conceived their plan of inaction. American firms have found ways to innovate and stay profitable even at $50 per barrel. For the Saudis and the rest of OPEC (and non-OPEC petrostates like Russia, as well), innovation in the face of a bearish market just isn’t an option. The longer the market stays this oversupplied, and the longer prices are this low, the more strain these regimes must endure. And with China’s economy reeling and Europe hardly looking to play the part of economic dynamo anytime soon, it’s hard to imagine demand for oil spiking anytime in the near future.

Barring some sort of unforeseen price shock caused by a significant disruption to a major supplier (which could happen, as WRM pointed out earlier this week), the global glut will persist, and petrostates are going to continue to feel the pinch. In this scenario, many of these regimes have few options but to crank output up as high as possible in an attempt to rake in what meager revenues they can. And while the producers engage in this price war, it’s consumers—and the global economy, excepting the oil and gas sectors—that are going to reap the benefits of cheap crude.

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