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Page added on February 22, 2015

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What is Saudi Arabia not telling us about its oil future?

What is Saudi Arabia not telling us about its oil future? thumbnail

It is popular these days to speculate about why Saudi Arabia cajoled its OPEC allies into maintaining oil production in the face of flagging world demand. As the price the world pays for oil and oil products has plummeted, the price OPEC members are paying in terms of lower revenues is high, even unbearable for those who didn’t save up for just such a rainy day.

Was the real reason for the decision to maintain production the desire to undermine rising U.S. tight oil production–which has now proven embarrassingly vulnerable to low prices after years of triumphalist talk from the industry about America’s “energy renaissance”? Were the Saudis also thinking of crippling Canada’s high-cost tar sands production? Was it Sunni Saudi Arabia’s wish to undermine its chief adversary in the region, Shiite Iran? Was the Saudi kingdom doing Washington’s bidding by weakening Russia, a country that relies so heavily on its oil export revenue?

The Saudis say explicitly that they believe non-OPEC producers must now balance world oil supply by cutting back production rather than relying on OPEC–meaning mostly Saudi Arabia–to do so. And, those cutbacks in the form of drastically reduced investment are already taking place in the United States, Canada and around the world as low prices are forcing drillers to scale back their drilling plans dramatically. It is not well understood, however, that almost all of the growth in world oil production since 2005 has come from high-cost deposits in the United States and Canada which has made the two countries easy and tempting targets for the Saudis’ low-price strategy.

Recently, investment manager Jeremy Grantham opined in Barron’s that Saudi Arabia has probably made the wrong decision. He explains as follows:

[T]he Saudis could probably have absorbed all U.S. fracking increases in output (from today’s four million barrels a day to seven or eight) and never have been worse off than producing half of their current production for twice the current price … not a bad deal. Only if U.S. fracking reserves are cheaper to produce and much larger than generally thought would the Saudis be right. It is a possibility, but I believe it is not probable.

First of all, he vastly overestimates the ability of the United States to increase its RATE of production, though he correctly assesses the production cost and longevity (or lack thereof) of U.S. tight oil reserves. Even the ever-optimistic U.S. Energy Information Administration believes that U.S. oil production will plateau in 2019 (not far above where it is now) and start to decline after 2020.

But, my concern is with Grantham’s assertion that the Saudis could have let U.S. drillers simply drill away while OPEC countries–meaning again, mostly Saudi Arabia–reduce their production without being worse off financially than they are now. U.S. tight oil production would presumably play itself out by 2020 or so and then start to decline allowing OPEC to recapture market share and raise prices again.

But there is one possibility which Grantham is blind to, one mentioned to me by a friend. It’s a big what-if. But then pretty much everything is a what-if when it comes to the secretive Saudis.

What if the Saudis are acting now to undermine U.S. and Canadian oil production because they realize that Saudi production will soon reach a peak, level out for several years and then start to decline in no more than, say, a decade? What if the Saudis fear that energy efficiency, fuel substitution (say, toward natural gas), and mandated greenhouse gas emission reductions will inevitably diminish their oil revenues beyond the next decade? What if this coming decade will therefore be the best time to maximize Saudi revenues per barrel? It would then make sense for the Saudis to cripple North American production now with, say, a year of low prices which should be enough to make investors skittish for many years thereafter. Then, the Saudis can capitalize on higher prices during the next nine years as the kingdom experiences its peak flows and before energy use reduction strategies threaten oil revenues.

(This assumes that they are right about the reluctance of investors to return to the tight oil fields and tar sands after having been walloped by the current low prices, something that would slow or prevent further growth in U.S. and Canadian oil production. If investment returns readily with any price increase, it is possible we could see wildly fluctuating prices due to short boom/bust cycles in the U.S. and Canadian oil industry, something I regard as possible but unlikely. This is because I expect many if not most of the current tight oil leases to pass into the hands of the major international oil companies as a result of bankruptcies of and distressed sales by the independent tight oil players in the coming year to 18 months. Those majors will take a more measured and patient approach to the development of those leases.)

Now, of course, no one knows what the Saudis know about their own oil reserves or anticipated flow rates. Saudi Aramco, the Saudi national oil company which controls all oil development and production in the country, is 100 percent owned by the government and therefore is not obliged to release information to the public nor submit to an outside independent audit. But the Saudis have already publicly stated that the world cannot count on them for more than 12.5 million barrels per day (mbpd). The country currently pumps about 9.7 mbpd of which it exports about 6.9 mbpd.

If the Saudis are acting now to cripple U.S. and Canadian production for the reasons my friend suggests, it means world oil supplies are going to be much more problematic after 2020 than many people suppose. It implies that at some point in the next 10 years OPEC will cease to be able (rather than cease to be willing) to balance world oil supplies. And, it suggests that no one else will be ready to act in that role when the time comes.

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5 Comments on "What is Saudi Arabia not telling us about its oil future?"

  1. Plantagenet on Sun, 22nd Feb 2015 11:32 pm 

    Grantham is right—-its just stupid for the Saudis to produce more oil so they can sell it cheaply—the Saudis would be better off producing half as much oil but selling it at twice the current price.

  2. Kenjamkov on Mon, 23rd Feb 2015 1:07 am 

    One year of lower price oil will devastate shale and tar sands. The price will skyrocket again, maybe higher than before. I wouldn’t think it was a stupid idea from their perspective.

  3. GregT on Mon, 23rd Feb 2015 1:36 am 

    The price that we are paying for a barrel of oil today, is higher than the prices that have historically caused recessions.

    Our economies do not run on $50/bbl oil, let alone $147/bbl oil. Our economies were built on, and run smoothly with, 20-30 dollar per barrel oil. Shale and tar sands ‘oils’ are mostly not affordable to our economies. If prices rise again even higher than before, the economic damage will be devastating, and prices will come down again, just as they have done now, due to a decrease in demand for oil that we can not afford.

    If anything, the Saudis not cutting back on production is good for countries that rely on large oil imports, and consumer based economies. Like the US. Net exporting nations will be hit the hardest, which should really beg the question as to why the Saudis are willing to take such a large economic hit, when they have the ability by themselves to keep prices high.

    Some believe that the Saudis are only trying to maintain market share, but oil is not just a commodity, it is the key resource that fuels the world’s economies. The demand will always be there, if economies can afford the higher prices. Which they obviously can not.

  4. jm on Mon, 23rd Feb 2015 7:31 am 

    Saudi ARE VERY EGOIITISCH

  5. Kenz300 on Mon, 23rd Feb 2015 12:46 pm 

    Canadian Tar sands are some of the dirtiest and most climate damaging fossil fuels……….. If we are to have any hope of dealing with Climate Change these high cost and very dirty fossil fuels need to be replaced with safer, cleaner and cheaper forms of energy.

    The wild fluctuation in price should give investors pause……. High risk investment dollars and high risk to the planet in the form of Climate Change.

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