The US shale revolution divided OPEC. Exporters of light sweet crude – such as Algeria, Angola, and Nigeria – lost nearly all of their market share in the US, while exporters of sour or heavier crude, including Saudi Arabia and Kuwait, have lost little.
Saudi Arabia seems to be hoping low oil prices will drive down investment in US shale energy
Because almost all crude oil produced by the Gulf States is sour, and most of the global surplus is sweet, any production cut by Saudi Arabia and its neighbours would not drive prices back up and rebalance the oil market. The only way to do that and prevent an OPEC breakup would be to reduce the production of light sweet crude, including by US producers, which would thus lose market share. If this occurred, oil prices could be expected to rise.
If, however, Saudi Arabia remains more committed to its strategic development objectives, low oil prices could persist. The key to the competitiveness of Saudi Arabia’s petrochemical industry was its use of natural gas and ethane, which was far less expensive than the oil product naphtha on which its global competitors depended. Now that the US is producing massive amounts of low-price natural gas and ethane, Saudi Arabia’s competitive advantage – and market share – is beginning to deteriorate.
The same goes for refining. Since the US does not allow exports of crude oil, the shale revolution pushed down the US benchmark price relative to international crude prices. US refiners took advantage of lower prices to increase their exports of petroleum products – threatening the market share of Saudi refineries in Asia and elsewhere.
Likewise, US companies have increased NGL production considerably, enabling the country to slash its liquefied petroleum gas (LPG) imports and expand its NGL exports significantly. As a result, Saudi Arabia has lost market share to US producers in Central and South America.
In refusing to cut its own production, Saudi Arabia seems to be hoping that low oil prices will drive down investment in US shale energy, undermining production growth there. Low prices may already have contributed to delays in America’s decision to begin exporting crude oil, and it seems they could amount to a net gain for the Kingdom.
Though Saudi Arabia’s motivation in not cutting production was probably almost entirely economic, low oil prices could also offer political advantages. The decline in prices is creating serious challenges for Iran, the Kingdom’s main rival in the region, as well as for the unstable, oil-dependent economies of Russia and Venezuela. None of these countries has adequate savings to cushion the blow of reduced revenues.
It seems likely that Saudi Arabia will continue to refuse to cut oil production, leaving prices low until market forces trigger a rebound. And even then, the price increase could be limited. After all, game theory dictates that, once the surplus is eliminated, the dominant producer must prevent oil prices from rising high enough to cause it to lose market share again. That means Saudi Arabia will try to compel non-OPEC countries to keep oil-production increases commensurate with growth in global demand.
It is in Saudi Arabia’s interest for oil prices to rise high enough to sustain its own economy, but not so high that they can sustain significant increases in non-OPEC supply. To keep prices in this ideal range, Saudi Arabia may even increase production again.
In the short run, excessively low prices could trigger political instability in some oil-producing countries, driving up prices. Delays in upstream investment could push prices above the ideal level in the medium and long term. But perhaps the biggest risk lies with the US shale-oil industry. US producers are likely to retrench, focus on sweet spots, improve technology, reduce costs, and increase production. At that point, Saudi Arabia’s current strategy may no longer be adequate to sustain its market dominance.
Anas Alhajji is chief economist at NGP Energy Capital Management
Copyright: Project Syndicate 2015