Saudis vs Americans - Why the oil price will not rise again above USD 60 per barrel anytime soon

"Our economy, thank God, is sturdy and it has enough strength to cope with the current economic and financial challenges," King Salman said in a nationally televised address to introduce the budget for 2017.

Source : CNBC

The New Saudi Arabia

On 22 December 2017, Saudi Arabia announced that the budget deficit shrank to $ 79B in 2016, well below a record $ 98B in 2015. This announcement is in line with the intention by the Saudi government to reduce it’s dependence on oil and invest more in infrastructure and government spending in order to stimulate the flagging economic growth.

For a country that used to be almost totally oil-dependent, this is a bold move. it shows that the new leadership under King Salman is doing all necessary to make Saudi Arabia a better place to live for it’s ordinary citizens as well as more welcoming for foreign nationals to the Kingdom.

Vision 2030

„My first objective is for our country to be a pioneering and successful global model of excellence, on all fronts, and I will work with you to achieve that.....“

Custodian of the Two Holy Mosques - King Salman Bin Abdulaziz Al-Saud

Vision 2030, the long-term plan to redirect the Saudi economy. It is also known as the „National Transformation Plan“, this massive project calls for the sale of Saudi Arabian oil and gas assets, including the huge state-owned „Aramco“.

„The first pillar of our vision is our status as the heart of the Arab and Islamic worlds“

Mohammad bin Salman bin Abdulaziz Al-Saud - Chairman of the Council of Economic and Development Affairs

The „National Transformation Strategy“ as it’s known, envisions a new approach to economic growth by reducing oil-dependency and that of Saudi Arabia becoming a global investment powerhouse as global hub between Asia, Europe and Africa.

Saudi Arabia’s bold and ambitious plans will be supervised, managed and executed through the „Council of Economic and Development Affairs“.

The economic blueprint encompasses all aspects of life :

1 – A vibrant society

2 – A thriving economy

3 – An ambitious nation

In order to achieve it’s objectives and ensure it has the necessary investment capital required, the Saudi government will take several steps that include 2 key goals :

1 - Sovereign Fund - Saudi Arabia will work to transform the Saudi Public Investment Fund to a „Sovereign Fund“ with assets valued to $2.5 trillion, making it the largest globally sovereign funds

2 – Aramco – the giant national oil company will be partially floated – a mere 5% - on the local exchange and the proceeds will be allocated to the new „Sovereign Fund“.

Aramco’s valuation estimates ranges anywhere from $ 400B to a astronomical $1 Trillion and therefore it’s expected that any floatation will be significant cash boost to the „Sovereign Fund“.

Pumping through the Pain

The financial challenges for Saudi Arabia stem largely from the fall in the global price of oil over the past 2½ years.

According to Bloomberg, 62% of government revenues came from oil and in 2017 this is expected to rise to 69%.

At around $50 per barrel, Saudi Arabia still makes a fortune each and every day. Saudi Arabia daily crude oil production is currently at the level of 10.64M, a slight increase over 2016.

However, Saudi Arabia’s involvement in 2 „proxy wars“ in Yemen and Syria as well a 2 year „price war“ with US shale-oil producers has resulted in less oil revenues and lost market share.

To this end, Saudi Arabia has reversed it’s export stance with the United States and is now focussing on China as it’s second biggest export market in direct competition with Russia which also exports to China. Both countries each share 14% of the Chinese crude oil market.

In the meanwhile, Russian output exceeded that of Saudi Arabia in January 2017 at 11 million bpd and reaching its highest level in 30 years.

As it stands now, Saudi Arabia has to contend on various „oil fronts“ with the Americans in the West, Russians in the East and Iran right across the Persian Gulf. And the Saudi’s are losing their patience.....

Iran - L’Enfant Terrible

Iran which is 90% Shia (Shiite) is the mortal enemy of Saudi Arabia which is 95% Sunni and considers itself the centre of the Arab and Islamic world.

Recent public execution of the prominent Shia cleric Sheikh Nimr al-Nimr has further inflamed the hatred between the two countries.

Under the leadership of King Salman bin Abdulaziz al-Saud, who ascended to the throne last year, the Saudis are challenging Iran on multiple fronts.

Saudi Arabia is determined to deprive Iran (and also Russia) of much needed oil revenues in order to deter Iran to build up it’s oil industry.

Iran has retaliated with potential output increases and has even threatened to sell crude oil at $1 per barrel on international markets now that sanctions have been lifted.

In addition, Iran has recently discovered an additional 15 billion barrels of crude oil and natural gas deposits which only will add to the global oil glut and depress crude oil prices even further.

In February 2017, the National Iranian Oil Company reported that Iran targets production of 4 MMbpd by April 2017 and estimates to produce 4.7 MMbpd of crude oil by 2022. For to achieve this, Iran plans to drill 500 new wells over the next five years.

However, even that Iran can significantly increase oil production in the coming years, it’s not making the necessary investments to achieve it’s objectives.

Black Gold

Hydraulic fracturing – or „fracking“ as it’s commonly known – is a drilling well stimulation technique that fractures below-surface rock using pressurised liquid containing mainly water, sand and thickening agents.

„Fracking fluid“ is injected into a wellbore to create cracks in the rock formations enabling oil and natural gas to be released and flow back to the surface.

Although it’s a very effective method of oil extraction, it’s one of the most expensive and very polluting at the same time (contamination of ground and surface water).

The „Bakken“ area is a large subsurface rock formation spanning across North Dakota, Montana, Saskatchewan and Manitoba. It was named after Henry Bakken who was a farmer after having discovered oil in 1951.

 Shale-oil drilling – also known as „fracking“ – gave oil producers the opportunity to extract „recoverable oil’ which is „trapped’ underneath the surface in oil wells. Drilling for oil started in the „Bakken“ area in 1953 but only through recent technological advances has the North Dakota oil boom taken of.

Starting in 2006, shale-oil production started at 200.000 barrels per day and increased steadily until the peak of 2015 at which time the „Bakken“ area is estimated to have produced over 1.2 million barrels per day.

After 2014, when the global oil price slumped from above $ 100 to below $ 30 per barrel, shale-oil production has been reduced significantly with many distressed oil producers going into insolvency or bankruptcy.

Depending on the drilling area, technology used and oil-extraction efficiencies, the cost of shale-production ranges anywhere from $40 to $60 per barrel with the key range being around $40-$50 per barrel.

At the average break-even level of $ 50, it’s not economic viable for US oil producers to start drilling and re-enter the global oil markets. However, easy access to capital and the lure that soon the oil price might recover - and maybe even go higher than $60 - has kept many oil producers going, notably „Marathon Oil“ , even though Bakken oil production dropped a whopping 9% in December 2016.

It is for this reason that Saudi Arabia does not want the oil price to go any higher than $60 per barrel because at that level, the resurgent US fracking industry starts to make profits again and would flood the global oil markets with crude oil which currently stands at 1-2 million barrels-per-day production surplus globally. US shale-oil producers could easily add 1 million barrels per day should it become economically viable, and that is something OPEC has to contend with.

The comparative advantage to other oil producers such as off-shore and deep sea oil drilling companies is that „fracking wells“ can be shut down and re-started very quickly so any upswing of the oil price can immediately be addressed and therefore the imminent surplus oil potential of the US fracking industry is something OPEC and it’s key member Saudi Arabia must take into consideration.

OPEC — the Organization of the Petroleum Exporting Countries — agreed to cut production late last year and the agreement has been holding to the surprise of many, especially Saudi Arabia which experienced many times of member countries not sticking to their quotas.

Oil prices have strengthened now for several months but in recent weeks, United States oil stockpiles have been building to a staggering 533.1 million barrels and therefore the prospects of stronger oil prices have faded, especially since US output is expected to reach 9 million barrels by the end of 2017.

The New Oil Order

The days that Saudi Arabia, Russia and OPEC controlled the global oil markets on their own is now history.

„Goldman Sachs“ has recently coined the term „New Oil Order“ which simply means that whatever happens in the global oil industry, it is not longer OPEC and non-OPEC countries like Mexico, Norway, Russia, Oman and a couple of others that decide over the price of oil.

In the „New Oil Order“ the US plays a key role due to the shale-oil revolution which has made the US a formidable oil exporter as opposed to a importer of foreign crude oil.

This has dramatically changed the dynamics in the global oil markets as the price of oil is no longer decided by the few such as OPEC and other non-OPEC countries. Since the US oil boom, the United States has become an oil producing powerhouse with many independents producing oil at an unprecedented scale not seen before.

The decision process no longer rests with governments only, many independent producers can „up-end“ the market very easily by increasing production at will. And since there are no quota’s to adhere to as well as no international production limits, US oil producers are free-handed to take not only their own economical-viability decisions, but oil production decisions as well which can have a significant impact on oil supply across the globe.

As in any commodity, many market forces come into play in determining price on base of supply and demand. Wars around the globe have added another dimension and now even technology has had a significant impact on the global oil markets.

Efficiencies in technologies will further enable oil producers from extracting oil using different extraction techniques and keep supply levels high.

But the biggest technological impact will be electrically-powered vehicles (EV) and battery storage improvements which will curb the demand for oil significantly.

At the other end, experts argue that the EV will not have a major impact on global oil demand as other sources of demand include military requirements as well as planes, ships and trains which transportation industry is expected to grow significantly thus offsetting any increase in the supply of oil.

The current oil supply and demand equilibrium is beneficial to the global economy because any significant variations in the oil price negatively affects world trade and ultimately results in more wars.

Only time will tell what will happen in the years to come but for time being, the price level of crude oil at around $50 is ideal, it strikes a good balance between supply and demand.

Saudi Arabia however wants a $60 per barrel level, that way it can boost oil revenues, increase market share and keep the shale-oil industry at bay. But it finds itself in a dilemma, when the oil price is too high – above $60 per barrel - US shale-oil producers can re-start at the flick-of-a-switch and when the oil price is too low, much needed oil revenues and market share will be lost. Finding the right balance will be of crucial importance so that Saudi Arabia can reach it’s objective of becoming a non oil-dependent country by 2030.