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Oil Prices Will Go Down But U.S. Shale Will Survive

WASHINGTON – After the oil production cuts recently announced first by OPEC and then non OPEC oil producers, oil prices rallied. This is because supply cuts must mean tighter markets and therefore higher prices. Well, looking at what most energy sector analysts say, this idea of a sustained oil rally is a dream that will soon end. And this is because there are too many exemptions to these announced cuts, too many special cases and too many opportunities to cheat, since rather modest total production cuts are to be spread thinly among many producers.

Oil prices will fall again 

Who is going to check about full compliance? Bottom line, expect oil prices to lose altitude again, as soon as hard data about production among OPEC and non OPEC countries will become known, probably towards the end of January. Keeping all this into account, while West Texas Intermediate, WTI, closed at about $ 53 on January 5, it is hard to believe that it will stay at that relatively high level for much longer.

What will happen to the U.S. shale sector? 

That said, the really interesting question, assuming persistent low crude prices, is whether the U.S. shale oil industry will be able to withstand another prolonged price squeeze.

If recent history is good guidance, I would say: yes, it will. Surprising everybody, the American oil shale sector, until a few years ago deemed to be profitable only assuming oil would stay at or above $ 60 per barrel, managed to survive, when oil beginning in 2014 went down to $50, $ 40, and even $ 30 per barrel.

Of course, the success record is quite uneven within a sector characterized by so many diverse players that differ in terms of size, profitability of their reserves and financial conditions. Many shale energy company, especially those carrying quite a bit of debt, just could not make it. They went bankrupt. Others were bought by stronger competitors.

U.S. shale oil sector made up of diverse players 

In truth, there is no such thing as a homogeneous U.S. shale oil sector. There are many energy companies operating in different states. Each one is different. And the chances to survive or thrive in a tough market environment because of low oil prices depend on many factors unevenly spread. Indeed, while examining companies, analysts have to take into account the specific geology that will affect production techniques and oil recovery levels and related costs, the company’s management skills, the amount of debt each company carries, the ability to apply in a timely manner state of the art new technologies, and a lot more.

Still, even taking to account that some companies are strong and some very weak, with many more in between, it is fair to say that the sector as a whole proved to be surprisingly resilient, given the low profit margins in a depressed oil price market.

Sustained production 

Yes, the total U.S. rig count went down, dramatically, following the 2014 price collapse. But overall production, with some ups and downs, did not go down that much. The shale oil sector proved to be quite flexible.

While large conventional operations cannot be brought on line, closed and restarted at will, the shale sector is far more flexible. And this means that shale operators do not need to bet on a 5 year window of high prices that will guarantee profits in order to start operations.

They can quickly respond to price fluctuations, producing more when prices are high; while shutting down production when prices drop below their break even point. Look, obviously it is not just like flipping a light switch. But you get the idea. Shale is nimble.

How much flexibility and resilience?

So, flexibility and resilience define the American shale oil sector. But here is the question. Is it possible for U.S. shale to become ever more productive and nimble? Or, at some point, no matter how much they try to cut costs, the energy companies hit a profitability wall?

While we know that the shale plays in the Permian basin in Texas can stay in business even with oil at $ 40 or even $ 30 per barrel, what about all the other reserves in Oklahoma, North Dakota and other states? If we assume prices going down to $ 40 or even $ 30 per barrel for an extended period of time, how many shale companies, many of them operating in far less favorable locations, have a realistic chance to survive, let alone be profitable? Can new fracking technologies perform more miracles, or has the sector become as productive as it can get?

How long can Saudi Arabia endure the adverse impact of lower oil revenue?

The honest answer is that we do not know. That said, we also do not know how long oil prices will stay this low. Indeed, we do not know how long Saudi Arabia, the world’s biggest producer and OPEC’s de facto leader, can endure the economic and fiscal impact of low prices without resorting to much steeper cuts in order to jack up prices and therefore state revenues.

We all know that Saudi Arabia’s oil industry will be profitable even with oil at $ 30 per barrel, because Saudi extraction costs are very low. But the problem is that the Saudi Government depends on high oil prices to finance practically everything.

While the Monarchy is trying to change things, right now the Saudi State needs to lubricate with cash infusions a rent based society in which hardly any Saudi citizen is engaged in truly productive activities.

Low oil prices hurt 

Which is to say that low oil prices hurt different producers in different ways. OPEC now has tried to drive prices up by announcing relatively modest production cuts to be spread among various producers. Some non OPEC countries indicated that they would also participate, with the shared objective of jacking up prices.

Based on what know, this time the trick probably will not work, because too many producers are saying one thing about cuts and then planning to do the opposite (keep production levels high, or in some cases, ramp up production).

When will Saudi Arabia announce serious cuts?

But at some point Saudi Arabia will start running out of cash; and so it will have to cut its oil production in order to drive prices up. This would help the Saudi state immensely in its effort to stabilize its finances. However, any Saudi move aimed at supporting oil prices would also help the marginal U.S. shale producers. Some of them are hanging tight, hoping for better days to come.

In other words, who will give up first? Will the U.S. shale sector be eventually defeated by prolonged low oil prices? Or will Saudi Arabia have to swallow the bitter pill and cut production (therefore giving up some of its market share) in a far more significant way in order to drive prices up, with full knowledge that this will help U.S. shale companies?

Bet on Yankee ingenuity 

All in all, when it comes to endurance and resilience in adverse market conditions, I would still bet on Yankee ingenuity. The American shale oil industry surprised the world by inventing and then deploying hydraulic fracturing (fracking) and horizontal drilling on a large scale, this way bringing on line millions of barrels of oil that was deemed to be unrecoverable. And then they delivered an even bigger surprise when they managed to make the entire sector much more productive and efficient in record time, when faced with a sudden crude oil price collapse.

None of this could be done, everybody said. And the shale oil people did it. May be they will keep doing it, surprising all analysts once again.




Oil Prices Will Stay Low

WASHINGTON – I am not at all surprised to see that the Doha oil talks aimed at finding an agreement about stabilizing output among major producers failed. Saudi Arabia would have liked to freeze production at current levels, which means at the Kingdom’s highest level in modern times, (more than 10 million barrels a day).

No deal with Iran 

However, it was obvious that Iran could not possibly have agreed to freeze its own production at current levels. Tehran wants to ramp production up to its pre-sanctions peak. And how could anybody have assumed anything else? Of course the Iranians want to increase their oil production and regain lost market share.

Therefore, no deal. As a consequence, oil prices are once again headed lower. There was a time in which low prices were really good news in the West. But now it is a mixed bag, especially in the U.S.A.

Oil was good news in America 

And how so? Well, because “unconventional oil” exploration and recovery –we are talking about shale oil– has been one of the brightest spots in the otherwise timid U.S. post 2008 economic recovery. Tens of thousands of new, high paying jobs made things better in many oil-producing states, from North Dakota to Texas.

U.S. oil in recession 

But now, lower prices are bad news for a sector composed primarily of small to medium-sized companies, many of them under capitalized and highly indebted.

For small U.S. energy companies it was easy to get bank loans when oil was at $ 100 a barrel, and therefore future profitability was not in question. But now it is at $ 40, possibly headed even lower. And therefore the U.S. oil patch is in a recession. Moody’s just downgraded many U.S. energy companies. Tens of thousands of good jobs have already been lost, with more losses to come. This will have a nasty effect in the affected regions, and some negative impact on the overall American economy.

Resilience 

Things are not awful across the board. In fact, the shale oil sector has proven to be much more resilient than most analysts had predicted. A combination of aggressive cost cutting and vastly improved production technologies allows at least some shale oil companies to stay profitable even with oil at $ 40. But this is only about some companies.

The other good news is that shale oil production is relatively flexible. It is not too complicated to shut down wells and then start production again in better times, when prices have recovered. Still, idled wells do not generate any income. Weak producers close down, or go bankrupt. Some may be bought by bigger competitors with deeper pockets.

Sure, at some point this cycle will end. Saudi Arabia cannot afford huge budget deficits for ever. Its bizarre policy of keeping production at these levels, (this way depressing prices), while the Kingdom needs to get into debt in order to fund current government operations (and that includes almost the entire country getting some money from the Royal Family) will end. But it will take a while. In the meantime, hard for U.S. oil workers to find other jobs that will pay so well.

Good news for consumers 

That said, depressed oil prices, while they hurt an important sector of the U.S. economy, on balance are positive. America is still a major net oil importer. Lower prices translate into a smaller balance of trade deficit. And for the average consumer cheap oil must be good news. Who can complain when finding lower prices at the pump? For tens of millions of American drivers low gasoline prices are equivalent to a tax cut. More money in their pockets.

The future of oil

That said, going forward, the real challenge for the U.S. oil sector is not Saudi Arabia flooding the global market. The real challenge will be new, non oil-based technologies.

Despite its uncertain beginnings, the electric car sooner or later will become economically viable. Elon Musk of Tesla has bet everything on making affordable, mid-sized electric vehicles, EVs. We are not there yet. Money losing Tesla may be will fail. But even if it does, others will follow. And when someone will hit the sweet spot with easy to recharge, attractive EVs with a good range that the average consumer can afford, it is good-bye to oil.

Saying good-bye 

And that will be a real good-bye. It will not be about temporary sector recessions, or fluctuating prices due to Saudi shenanigans. It will be the end of the oil era.

Here in the U.S. at least someone will be prepared for this gigantic transformation. But economies such as Russia, Venezuela and Saudi Arabia which depend entirely on oil revenues to fund “everything” will be in deep, deep trouble.

All told, better to be in America. This society, with all its problems, is still capable of promoting change while embracing it when it comes.




Saudi Arabia’s Oil End Game

WASHINGTON – More than a year ago, when it became obvious that massive increases in US oil production (thanks to shale and fracking) had created a global glut, Saudi Arabia did not react in the usual manner. It did not work with its OPEC associates to cut the cartel’s production in order to diminish supply and support oil prices.

No more production cuts

No, Saudi Arabia stated instead that it would let the market determine a new balance. No supply cuts. From then on supply and prices would be determined by actual global demand.

At that time it was widely believed that the Saudis wanted to kill US shale production. The conventional wisdom was that relatively expensive fracking operations in the US could not survive with oil below $ 70 per barrel. They just could not. And, in truth, many US shale producers have been hurt badly by the precipitous price fall allowed by Saudi Arabia. Some had to fold.

US shale sector very resilient 

However, a significant segment of the US shale oil industry has proven to be remarkably resilient. It streamlined operations, and it has quickly become far more efficient. Some shale oil producers claim to be profitable with oil at $ 40 or even $ 30 per barrel.

In other words, the US shale oil industry has been badly wounded by the oil price collapse; but it is still very much alive. This is astonishing. Only a couple of years ago most industry analysts asserted that the shale sector could not survive with oil prices this low.

Did Saudi Arabia miscalculate? Did the Saudis wrongly assume that in just a few months they would have smothered the Americans? Or may be they have some other goal in mind?

Saudi Arabia needs high oil prices  

Be that as it may, whatever the Saudis are trying to accomplish, they need quick results. Indeed, the massive over supply they created with the intent to kill or weaken less competitive rivals did what it was intended to do. It caused a glut and an oil price collapse.

The problem is that rock bottom prices are beginning to hurt the Saudis.

It is no secret that beyond oil Saudi Arabia has no other sources of real revenue. And it is also well-known that the stability of the Kingdom is based almost entirely on the ability of the Saudi Royal Family to keep subsidizing directly or indirectly almost the entire country: that’s 29 million people. These subsidies, paid for with oil revenue, buy consensus, social peace and popular support for the Monarchy.

Sharply lower oil revenues, sustained over several years, will translate into growing public deficits, and therefore into a diminished ability to throw cash around as a way to keep the people happy.

Of course, for the moment Saudi Arabia can rely on its significant dollar reserves. But they are beginning to dwindle. The government has also started borrowing in order to finance its growing yearly deficit. At some point, its ability to subsidize the country will be impaired.

Unsustainable 

Let’s be clear. We are still far from an economic or fiscal emergency. But, assuming no policy changes regarding oil prices, at some point this course will become unsustainable. Soon enough, the Saudi government will need higher oil revenues.

As noted above, American energy producers are hurting. Some are gone, or will be gone pretty soon. Still, the news from America is that the shale oil sector is far more resilient and flexible that anybody thought.

At least some shale producers have become far more efficient. They can start and stop production without creating havoc. Of course, some shale oil plays cannot be profitable with crude below $ 40 or $ 30. But many are. If and when OPEC will decide to go back to its old ways –cutting production in order to support prices– expect the US shale sector to start ramping up production.

What is the game plan? 

Given all this, assuming that the Saudis must understand what is going on, one wonders what they have in mind. What do they plan to achieve by allowing oil prices to fall more and more? Whom are they trying to squeeze?

What is the game plan? I believe that the target is Iran. Saudi Arabia sees Iran as its only rival for regional influence, when it comes to politics, military assertiveness (Iraq, Syria, Yemen) and religious activism. Iran is Saudi Arabia’s existential threat.

Hit Iran where it hurts

For this reason the Saudis are trying to hit Iran where it can really hurt: oil revenue; this way hopefully undermining the legitimacy of the government run by the Ayatollahs.

It is clear that if Saudi Arabia needs high oil prices to keep its people happy, so does Iran. Who knows, may be Saudi intelligence has information we do not have about the fragility of the government in Tehran.

If protracted low oil prices end up undermining the Ayatollahs’ regime in Tehran, then this semi-suicidal, low oil price strategy pursued by Saudi Arabia all of sudden makes sense.




A Very Weak American Economy

WASHINGTON – The slow but steady decline of the US economy should be the main theme of this unfolding and contentious presidential election campaign. But it is not. The recent steep Wall Street drop may change all this, (the Dow Jones lost another 530 points on August 21, making it the worst day of a very bad week), but I would not bet on it. In fact, optimistic analysts are on TV telling investors that this huge Wall Street loss is in fact just another temporary glitch, and thus a wonderful opportunity to buy really cheap stocks.

“Anchor babies” 

Regarding the presidential campaign, forget about the economy. The most recent headline is about Donald Trump’s proposal to repeal or modify the 14th Amendment to the US Constitutions that grants citizenship to all those who were born in the US. His point is that the Constitution has been abused by armies of pregnant foreign women who slip into the US in order to deliver what are now called “anchor babies” on US soil. As they are now mothers of US citizens, they can try to make a case to stay in America, despite their foreign status.

Millions of babies? 

So, there you go. “Anchor babies”. This is the burning issue. And how many “anchor babies” do we have? Millions? Hundreds of thousands? No, we are talking about a few thousand, at most.

Look, there is plenty of evidence of criminal enterprises that provide logistical and medical support to pregnant foreign women, so that they can come here, and give birth in the US. All this needs to be stopped. But, while real, this is hardly a crisis of catastrophic proportions.

Under performing US economy

The real issue that should be discussed by all those who aspire to be President is a consistently under performing US economy. (For a cogent, detailed and rather scary depiction of US economic decline, read the WSJ op-ed by Mortimer Zuckerman, Who Will Get the Dreary Economy Going? August 21, 2015).

Unfortunately, it is very difficult to fight against economic mediocrity, especially since more than half the country, including respected analysts, have gotten used it. In fact many tell us that this mediocrity is after all quite good.

Mediocrity looks OK

In truth, the US economy is not facing imminent disaster. On the contrary, it has been chugging along for a number of years at a slow, but semi-respectable 2% a year rate of growth. Not great, but a lot better than Europe. Unemployment has gone down, and it is now back to about 5%.

Most analysts who speak on Bloomberg TV, CNBC or Fox Business say that things are more or less OK. Not great, perhaps. But alright. You see, more Americans are employed. And this means more disposable income. And this will translate into more sales, and therefore more demand for good and services that will lead to better economic performance. As for the steep Wall Street decline, we are told not to worry. We always have corrections every now and then. The important thing is that the economy is on solid foundations.

Really?

Fragile foundations 

Look, the fact is that the US economy if fundamentally fragile, notwithstanding the ZIRP, (zero per cent interest policy) decreed by the US Federal Reserve many years ago. Which is to say that, despite this extraordinarily long period of monetary easing, economic activities have not picked up.

2% growth is well below our 3% historic average. On top of that, we have the lowest level of labor force participation in decades. This means that far fewer adult Americans are employed, compared to our historic averages. Millions of those who now are lucky enough to have a part-time job would rather have full-time employment. And most new jobs are in low pay service industries. Very little new employment is created by wealth-generating manufacturing.

The end of the energy boom 

All this indicates an anemic economy. But wait. It gets worse. Much of the (modest) growth that America experienced in the last few years was due to the extraordinary shale oil boom. But now the world is awash in oil. And there is no sign that this glut will go away. This means a real recession in the oil sector that is driving down energy companies and all their suppliers. Translation: depressed energy and energy related stocks, with dramatic loss of what used to be good jobs for all the oil companies and for the vast universe of suppliers and vendors connected to them. Add to this the negative ripple effects on communities that started thriving because of the extra money brought in by the energy business, and you get a rather dark picture.

Diminished China

Last but not least, we have China on the verge of a crisis. The US may not have much direct exposure to the Chinese economy. But the rest of the world does. Japan is affected, and so are Germany, Taiwan, Thailand, and South Korea. And we do business with all of them.

Beyond that, China’s slow down has already had a dramatic impact on the economic performance of all its raw  materials suppliers. Brazil, Australia, South Africa and Indonesia are in big trouble. Major mining companies are looking at disastrous numbers, because China does not buy much from them anymore.

Can anybody seriously believe that, while the world is headed towards an economic freeze, America will be miraculously unaffected?

Now, if China’s woes were just a glitch, well, this problem would go away. But we have many indications that China has entered a new slow growth economic era, while it is trying to deal with monumental debt, and massive industrial over capacity. Here is one sobering statistic. The Caixin China Manufacturing Managers’ Index just fell to a 77 month low. As I said, this looks like a new trend.

Therefore, forget about China growing at 7%. Forget about its ability to absorb massive amounts of iron ore, copper or whatever else.

Shaky America 

So, here is the picture. The American economy has recovered since 2008, but very slowly, notwithstanding the historically unprecedented monetary stimulus. Consumption is not buoyant because most Americans are still recovering from the over spending of 10 years ago. The US oil industry, a rare bright spot, is now clearly in serious crisis, while world trade is depressed because of China’s slow down.

Are we headed for a recession? Probably. (If nothing else, as we get a recession every 7 or 8 years, we are due for one anyway). Certainly there is nothing out there that inspires great confidence.

Wanted: An economic growth agenda

So, how do we get out of this? It is not difficult to identify the issues that need urgent attention in order to strengthen our foundations. We would need a skilled combination of tax reform, public education reform, targeted training programs, regulatory reform, and a lot more. The problem is that putting all this together in an eye-catching, compelling campaign platform is really difficult.

Sadly, it is a lot easier to listen to Donald Trump and others talking about “anchor babies”. As for Trump’s recipe for fixing the economy, he has one, and it is very simple. “You should elect me president, because I am the only one who has the proven experience to get things done. I know these things. The professional politicians are all talk and no action. I’ll take care of things”. Well, this is the level of detail we are getting, so far.

I hope that someone else can do better than this.




Lift The US Oil Export Ban

WASHINGTON – At the time of the first OPEC oil embargo (1973-74), in an attempt to protect shrinking domestic oil supplies, the US Government passed a law that forbids exporting American crude oil. 

Plenty of oil

Whatever the merit of that policy, now –40 years later– we are in a totally different environment. While in the 1970s we feared shortages, now the world has plenty of new supply.

And we know that America increased its production, in a major way. Time to do away with the export ban? Not so fast, some argue. Even though we are producing a lot more oil, we are still a major net oil importer. It makes no sense to export oil when we are importing it.

This argument would make perfect sense, but only if any oil, regardless of its origin, were essentially the same. But we know that there are different types of oil.

Lift the export ban

And this is why it would make sense to lift the export ban. Many have spoken on this issue, including MIT Professor John Deutch, a highly respected energy expert with a distinguished public service record. (Amplify the Oil boom by Liberating US Exports, The Wall Street Journal, August 12, 2015).

Here are the facts. America now produces a lot more oil. However, much of the additional supply (coming mostly from shale deposits in North Dakota), is light crude. Nothing wrong with that. Except that most US refineries are designed to process heavy crude. For this reason it is more difficult for US shale producers to sell their product domestically. In many instances they are forced to sell at a discount.

If the same shale oil producers were free to sell internationally, they would get better prices from buyers in other countries whose refineries are designed to process light crude.

Buy heavy crude from Canada 

Well, and what about America? If we sell abroad, then we lose some of this additional supply. This means that we shall have to import more. Yes, this is true.

But there is a solution to this. There are enormous quantities of heavy oil in Western Canada. (in fact Canada has the third largest proven oil reserves in the world, surpassed only by Venezuela and Saudi Arabia). Of course, we already import quite a bit of this Canadian crude.

But we could get more, a lot more.

If we built the proposed Keystone pipeline, it would carry much more Canadian crude all the way down to Texas. The Texas refineries are designed to process heavy crude.

Open energy markets 

This way, by opening up different avenues for different types of crude, each one would get to its optimal destination.

This sounds reasonable. But it is very difficult to do, mostly for political reasons. Lifting the oil export ban may be a bit easier. There seems to be a bipartisan coalition in the making in the US Congress that would have enough votes to pass a new law that would repeal the export ban. This is hardly a done deal, but it looks possible.

Keystone pipeline blocked 

Unfortunately, the Keystone pipeline project is blocked, at least until Barack Obama is US President. Indeed, just like exporting US oil, getting more oil from Canada is not based on market forces, old-fashioned demand and supply. Creating this channel for additional supplies of Canadian oil is entirely contingent on President Obama approving the Keystone pipeline. And he will not do this.

Mind you, this pipeline project has been reviewed, assessed, and vetted a million times by the US State Department, the agency technically in charge because this is a pipeline that will go across the Canada-USA frontier. Armies of experts who worked on this for many years could not find any flaws with this project.

Energy policy dictated by ideological prejudice 

But President Obama will not approve it, simply because powerful US environmental groups are opposed to it, as a matter of principle.

They just do not like any new infrastructure that will lead to any oil consumption increase, foreign or domestic. In other words, it is all about ideological prejudice.

Sadly, this is how we craft the energy policy for the most important economic power in the world.




THE US Shale Industry Survived Oil Prices Collapse

WASHINGTON – When oil prices suddenly collapsed, going from $ 100 per barrel to $ 50 or less, the almost universal prognostication was that the US shale oil industry wad dead. Shale oil is difficult to extract and therefore a lot more expensive than “conventional oil”. Given the very low margins, shale oil can be profitable only if crude prices stay above $ 70 or 80 a barrel.

Kill shale producers

As we know, oil prices collapsed because Saudi Arabia and OPEC decided not to cut production in order to stabilize prices after the world experienced a supply glut thanks to US shale oil coming on line on a massive scale.

Many observers believed at the time that Saudi Arabia allowed the price free fall because it hoped to kill most US high cost shale producers. With oil at $ 60 or lower per barrel a majority of US producers would simply have to shut down. With global crude prices that low, US shale oil producers could no longer generate any profits, because of their high cost and low margin operations.

Well, the predicted US shale oil industry collapse did not happen. And this is mostly because the impossible actually happened. Many US producers learned new ways to cut costs, in a major way –and very fast.

Dramatic cost cutting

This sounds impossible. Oil production is a complicated, cumbersome and expensive process. Shale oil production even more so. You spend a lot of money acquiring drilling rights, spend more money drilling a lot. If you are lucky, you find some oil. After that, you have to set up expensive, capital intensive operations.

All this is based on the expectation that after you start producing you will generate a reasonable profit. But this expectation rests on the assumption that crude prices will stay within a certain range. If prices collapse, you are in a bind. Below a certain point, you cannot recover your initial investment in the drilling operation, and you start losing money. Therefore, you shut down, or you go bankrupt, or both.

Learning curve

But these generally accepted parameters no longer apply. At least not to all shale oil producers. And here is why. Believe it or not, the fact that shale oil wells production cycles are shorter than production cycles from conventional wells has become  an opportunity for many industry practitioners to adopt new cost saving technologies that made the next shale well cheaper and more productive.

It would appear that more drilling resulted in more experimentation and eventually in higher productivity and better margins. At least in some instances, producers indicate that they have higher margins now, with oil at $ 65 than what they had when oil was at $ 95.

Let’s be careful. This does not apply to all. There are thousands of shale oil producers in the US, some of them quite small. Some small companies carry a lot of debt. Their business model is based on high prices. Therefore they will not survive. But many others can and will.

Will shale oil survive?

The issue of shale oil long term staying power is far from settled. How far can producers go in their efforts to cut costs via the adoption of improved drilling technologies? How much more shale oil is out there? In other words, is American shale a real game changer, or is it just an interesting but temporary phenomenon?

We still do not know that. That said, Saudi Arabia’s low prices policy may have unpleasant repercussions for the oil kingdom. There is no question that the Saudis can still make a good profit with oil prices at $ 60 or even less, because their extraction costs are very low.

Will low oil prices hurt Saudi Arabia?

But Saudi Arabia desperately needs a huge oil revenue to keep the country going. Simply stated, beyond oil there is practically nothing else in Saudi Arabia. Oil revenue finances almost everything. A long season of diminished revenue may cause significant cash flow problems. And cash flow problems may turn into political issues in an autocratic country in which loyalty is bought in large measure with subsidies and other forms of public largesse.

In the end, a policy that supports low oil prices forced the US shale oil industry to adjust very rapidly. Can the Saudi state adjust just as rapidly? I wouldn’t bet on it.




Low Oil Prices Are Good For America

WASHINGTON – Oil prices keep going down, and down. We are now around $ 50 a barrel, or even lower. On balance, this should be good news for America, still a major net energy importer. Yes, we know that the US has made news by increasing its domestic oil production by 4 million barrels a day in just a few years, an astonishing accomplishment. Right now, US energy companies have to face this headwind of low prices that cut into their current and projected profits. Many of them will not make it. But the rest of the US economy will benefit.

Energy sector will suffer

Let’s put these recent developments in context. Clearly low crude prices are hurting the large and now expanded US energy sector, from energy companies to the vast universe of oil services companies and various manufacturers that produce the equipment necessary for oil exploration, drilling, transportation, storage, distribution, and what not.

It is also clear that the industry outlook has changed, dramatically so. The US shale oil sector looked very attractive with oil at $ 100 or $ 90 a barrel. However, If we are forecasting oil at $ 50 for the indefinite future, all of a sudden this business looks pretty awful.

In fact, we can safely predict that many smaller and financially weaker US energy companies will go out of business pretty soon, because their production costs are too high. Expect bankruptcies and consolidation in the US energy sector, while investors may as well forget about high profits. Energy stocks are way down, and there is no hope for a speedy recovery.

Oil producing states to be hit hard

Obviously this oil sector recession will hit hard the states that benefited the most from the recent energy boom. Think of North Dakota or Texas. Expect cascading negative effects, from collapsing real estate prices to empty shopping malls, or restaurants closing down in oil boom cities.

That said, while parts of America will suffer, and the US energy sector and all its suppliers and vendors will have to retrench, substantially lower oil prices is unequivocally good news for the broader US economy.

America as a whole will benefit

Notwithstanding the incredible domestic production surge, America still imports about 50% of the oil it consumes. Lower oil prices benefit our balance of trade. Billions of dollars stay at home. Besides, today the average American is paying a lot less for gasoline, and this relief at the pump translates into the equivalent of a tax cut, or a wage increase.

When will this end?

That said, how long is this low oil prices season going to last? This is very difficult to say. Energy markets do not behave like other markets. Right now it seems that Saudi Arabia –the world’s largest exporter– has no intention to cut production, because it is focused on retaining market share. Therefore the Kingdom is willing to sacrifice profits in order to keep all its customers.

Saudi Arabia controls this game

The question is for how long? Well, here the topic shifts from economics to politics. Saudi Arabia can still make money selling oil even with prices at or below $ 50 a barrel. But the country’s budget is based on a much higher oil revenue. The Saudi Government has already announced that it will run a budget deficit on account of lower oil revenue.

In the near term, this is not a problem. Saudi Arabia has a very large financial cushion, estimated at around $ 750 billion dollars. Therefore it can afford to endure the pain of lower oil prices for quite a long time –years not months. But not for ever.

So, the question is for how long? Are the Saudis willing to deplete their cash reserves in the hope of seeing their financially weaker competitors go belly up much sooner? It is clear that unless there is going to be a massive demand increase, oil prices will recover only when supply will be cut. If no one is willing to turn the taps off, then we shall have to wait for the weakest producers to be driven out of business.

Will the US shale oil sector survive?

Back to America, this totally new situation is clearly a major hurdle for the relatively young shale oil sector. This low prices “stress test” will show if shale oil is truly viable, or if it was just a niche market made possible by very high oil prices.

We have to see if the US energy companies have the ability to lower their costs and stay in business, even when faced with dramatically lower profits.

 




Saudi Arabia Wants To Kill US Shale Oil

WASHINGTON – Saudi Arabia’s oil end game is to let prices fall and stay low for as long as possible in order to kill the less competitive American shale oil producers. It is clear now that Ali al-Naimi, Saudi Minister of Petroleum and Mineral Resources, is betting on Saudi Arabia’s ability to force high cost US shale oil out of the market.

Conventional wisdom about shale oil

Here is the conventional wisdom. Sustained high oil prices encouraged American companies to exploit US shale oil deposits. This new US produced oil means less oil imported from Saudi Arabia.

While shale oil profit margins would not be huge, (extracting oil from shale is much more expensive than getting “conventional oil” in Saudi Arabia), as long as oil stayed at around $ 100 per barrel, the Americans could sell their crude at home, make money and displace Saudi imports.

But if oil prices went below $ 80 or $ 70 a barrel,  there is no way that US shale producers could stay in business. Their production costs are just way too high.

Therefore, since Saudi Arabia’s production costs are much lower, it is smart to squeeze the new American competitors out by forcing oil prices down through over supply. Saudi Arabia still makes money with oil below $ 60 a barrel. But the Americans would not be able to stay in business and will be killed. Therefore let’s produce at full throttle, inundate the markets with excessive supply, and let prices go down and down. Unable to make any profit from their expensive oil, the US shale oil producers will simply go out of business. Saudi Arabia this way will regain its lost US market share.

What is the Saudis are wrong?

But what if the basic assumption about shale oil being unprofitable below $ 100, or below $ 90 is untrue? What if US shale oil producers can cut costs, and manage to survive and stay profitable even with oil below $ 60 per barrel?

Well, then we have entered a different era. The post-OPEC oil era. It would be really ironic if it turns out that Saudi Arabia’s effort backfired. Indeed what if the American shale oil industry will win by  demonstrating that unconventional oil producers are in fact much stronger than anybody thought?

American ability to innovate

So, the real issue at stake here is American ingenuity and the ability of the US shale oil industry to cut costs and stay profitable, even when oil is below $ 60 per barrel. Is this possible?

Until yesterday everybody would have said “no”. My gut instinct is to say “yes”, it is possible. I am basing this optimism not on any insider knowledge of the new extracting technologies being rolled out, but on the industry track record so far.

It could not be done

Please do keep in mind that almost all energy experts have consistently underestimated the strength of the US “unconventional” oil sector. Until just a few years ago, the consensus was that shale oil would never be profitable. Too many technical hurdles that could be addressed only at a spectacularly high cost. Well, that was not true. Hydraulic fracturing (“fracking”) and horizontal drilling made shale oil extraction possible and profitable. In just a few years the US added almost 3 million barrels a day to its total production. Amazing.

Then it was said that, even if some shale oil could be extracted at a profit, (assuming oil at $ 100 per barrel), this “mini boom” would end soon, because there was not that much shale oil, while shale oil wells would yield very little compared to conventional oil deposits.  Well, that was also proven wrong. Plenty of shale oil.

Enormous pressure to innovate

That said, can more and quickly deployed technological innovation keep the American shale oil industry in business? The pressure is both huge and sudden. Obviously the precipitous decline of oil prices forced everybody to go back to the drawing boards.

Is it possible to invent something new that will allow major productivity gains while reducing drilling and extraction costs? Can the US shale oil industry prove to be far more resilient than the Saudis assumed?

I do not know for sure. But, as I said, we have been surprised before, many times. The US energy industry is clearly engaged in a historic technological race, and it just may win.

If America wins

So, here is the picture. Saudi Arabia is trying to kill US shale oil producers, because their unexpected success is threatening its market share. But if the Americans manage to survive by demonstrating that they can make money even when oil prices hit bottom, and stay there, then they will kill OPEC.

Saudi Arabia needs high oil revenue to pay for everything

Indeed, let’s keep in mind that while Saudi Arabia is a low-cost, high volume producer, the Kingdom needs an enormous oil revenue (based on selling oil at or above $ 90 per barrel) to finance almost everything. While Saudi Aramco will stay profitable with oil at $ 50 per barrel, the Government of Saudi Arabia will not be able to function they way it is used to with a drastically diminished oil revenue. Less oil revenue means fewer subsidies for the poor, fewer investments in public services and infrastructure. In case you wonder, beyond oil Saudi Arabia has no other revenue.

I am really looking forward to the day in which Saudi Arabia, Russia, Iran and Venezuela will be hit hard by falling oil revenue. There is plenty of “unconventional” oil not just in America but around the world.

American energy companies may be able to prove that it is possible to extract it and make a profit even when oil prices are 50% below their peak. In so doing they will break the price-fixing power of the OPEC cartel which was based on the assumption that there is only a limited oil supply, while just a few countries control a huge chunk of it.

 

 

 




Low Oil Prices Is The Only Bit Of Good News For Most Western Countries

WASHINGTON – Western financial and business publications are now celebrating the collapse of oil prices. This unexpected Christmas gift is certainly a nice surprise. Lower oil prices mean lower gasoline prices. And in countries where people drive a lot, like the US, lower prices at the pump have the same effect of a tax cut, or of a nice bonus in your pay check.

More money to spend

And, of course, less money spent on gasoline means more disposable income that can be spent on Christmas shopping and/or other things. As our Western economies are largely fueled by consumer spending, this is good news for retailers and for anybody else producing and distributing goods and services that appeal to millions.

Thank the Saudis

So, cheer up and say thanks to Saudi Arabia, and to its “keep the taps turned on” policy that is at the root of the over-supply that has caused oil prices to collapse.

Look, there is nothing wrong in celebrating a bit of good luck. But this is what it is: luck. This relief at the pump we are enjoying now has nothing to do with improved economic policies in Europe, or in Japan. So, let’s not get carried away.

This is the only good news

Indeed, I am concerned when I see that lower oil prices is essentially all the good economic news we have got, these days. Most Western economies are not well. In fact some are doing quite poorly. The innovation drive is gone. There is no meaningful growth. Just look at the Eurozone.

If our (somewhat) improved economic outlook depends entirely on finding ourselves on the right side of an oil price war started by Saudi Arabia in order to preserve its market share, then we are in really bad shape.

Can we enjoy low gasoline prices and still plan ahead?

By all means, let’s pocket the Christmas bonus. Let’s enjoy the benefits of lower gasoline prices.

However, if we were smart, we would think about ways in which we could create new enterprises and new wealth, no matter what the Saudis do, or do not do, to manipulate the price of oil.

The trouble is, I doubt that we are smart enough.

 




Will America’s Shale Oil Kill OPEC?

WASHINGTON – The incredible decline of world oil prices, (now at $ 66 per barrel), is due to three reasons. The first one is lower demand due to the prolonged economic slow down in Europe, in Japan, and to a lesser extent China. The second one is the significant increase of US domestic production –due to the massive development of shale oil– that caused a substantial decrease of US oil imports, this way adding to total supply available to other buyers. And the third one is Saudi Arabia’s ability to convince all OPEC members that, despite lower demand, the oil producers’ cartel should not cut supply in order to strengthen prices.

Market prices?

Well, what do you know, without artificial supply manipulation, it looks as if oil prices for a while at least will be determined by old-fashioned demand and supply.

Target US shale oil

That said, it is quite obvious that Saudi Arabia’s objective is to target US shale oil producers, in order to kill or at least weaken what the Saudis view as the major threat to their world energy dominance.

The Saudis bet that a prolonged period of low oil prices will put many small and medium-sized US companies that invested in shale oil out of business.

The conventional wisdom is that extracting oil from shale is very expensive. Therefore, it does not make sense to invest in shale unless oil prices stay above $ 80 per barrel.

By having all OPEC countries continue to produce at the same rate, Saudi Arabia is purposely flooding an already over supplied market, this way causing oil prices to fall more and more. The hope is that many, if not most, US energy companies extracting shale oil will go bankrupt or exit the sector, because it is assumed that they cannot make any money when oil prices are at $ 65 a barrel or lower.

So, Saudi Arabia is trying to kill the US shale revolution. Without this additional American production, OPEC will regain its ability to control prices through the manipulation of supply. Will this plan work?

Will US shale oil companies survive?

There is no question that many US small shale producers, especially those that carry huge debts, are doomed because they need oil prices at $ 65 per barrel, or higher.

However, many experts believe that most shale producers will survive this profit squeeze. As it always happens in a crisis, there will be painful consolidation. Smaller companies will be bought by bigger ones. Production will be concentrated in the shale regions where drilling is easier and cheaper. And there will be additional investments in cost cutting technologies and in enhanced recovery methods that allow companies to get more oil without the substantial cost of drilling many more wells.

In other words, as of now it looks that Saudi Arabia’s strategy aimed at killing the US shale oil sector will cause a lot of trouble, but that it will eventually fail.

Pain for OPEC members and for Russia

In the meantime, Saudi Arabia’s low oil price policies are inflicting a lot of pain on many OPEC members that heavily depend on oil revenue to finance most of their public spending. Iran and Venezuela will suffer greatly because their economies are weak, while their budgets are predicated on getting substantial revenue from high crude prices.

And Russia, not on OPEC member but a major oil producer, will also suffer because energy exports represent most of its revenue from foreign trade. Sure, Russia over time has accumulated substantial cash reserves. Therefore, it can finance current state spending by tapping these funds. The question is: for how long?

Indeed, should this low oil prices season go on and on, all bets are off. How long can Venezuela go on with a lot less oil money coming in? Ditto for Iran, and eventually for Russia. And even Saudi Arabia would have to revise its public spending plans, if it believes that its oil revenue will be curtailed for many years to come.

America bets on cost cutting technology

Here in America the hope is that the technological revolution that made shale oil production possible and profitable will continue. Or have we reached the limit on cost cutting innovation? I hope not. If you are a pessimist, please remember that until just a few years ago most oil experts believed that getting oil out of shale would never be profitable. 

That said, optimism alone is not enough. Obviously the long-term viability of the US shale oil sector hinges in large part on its ability to stay profitable by reducing production costs. If this proves to be an impossibility, then the high cost US shale sector will be vulnerable to price fluctuations, just like this one. If oil prices stay low indefinitely, US shale may eventually die, or at least production will be restricted to far fewer, lower cost areas.

Will America kill OPEC?

If technological progress will instead continue in the shale sector, then America will be the high volume, low-cost energy producer that killed OPEC. Assuming that US energy companies will be able to stay profitable with oil at current or even lower prices, increased supply of abundant and cheaper oil will benefit all energy products consumers across the world.