25.01.2015 Author: Viktor Mikhin

Saudi Arabia: Oil War to the Bitter End

3422222Interesting news came from the foggy shores of Albion. The British newspaper The Telegraph, which has repeatedly been noted to be in close ties with the American capital, again decided to stand up for its big brother and scare the world with new tales about the horrors of oil. And this time it took on the erstwhile British ally – Saudi Arabia.

“The further decline in oil prices could hit hard on the most influential member of OPEC,” The Telegraph categorically stated.  “Saudi Arabia has won the opening battle of its radical oil strategy by forcing prices lower. But the kingdom is about to enter into a dangerous new phase in its war to regain control of the world’s oil market,” the British newspaper frightens the world.

It is interesting, to what this “disinterested” intercession for its big brother is due. A chest just opened – the so-called shale revolution, widely publicized in the West, is not only failing, but coming to a standstill, falling apart before our eyes. Here is just one, but a very vivid example. As reported on the website of the oilfield services company Baker Hughes, in only one week the number of drilling rigs for oil production in the US fell by 61 units. This is the largest decline since 1991 – the year of world oil market volatility associated with the events in the Persian Gulf. We recall that the indicator of the number of working rigs is one of the most sensitive indicators of the state of the oil industry. The current decline in the number of working units is noteworthy because a significant number of them conduct horizontal drilling for the production of shale oil.

Other examples only add dark colors to the palette of the shale revolution’s bleak picture. For instance, the management of the largest independent oil company Continental Resources working in the Bakken field in North Dakota announced that it will not invest in new drilling in 2015 if OPEC does not cut quotas and there is not a steady upward trend in prices. The head of the company Harold Hamm expressed the hope that there will be a positive decision, prices will soon stabilize in the range of 85-90 dollars per barrel, and OPEC members will understand that “we feel that we have reached the bottom rung price, and we will see a sharp increase in the price soon enough.” However, despite this optimism, Continental Resources still slashed the capital expenditures of $600 million planned for 2015, and sold off its oil hedge instruments for 2014, 2015, and even 2016 with a total value of $433 million.

Continental Resources is not alone; ConocoPhillips also refused to drill new wells in shale deposits, particularly in Colorado, and reduced costs for 2015. Another company, Pioneer Natural Resources, decided to wait to increase the number of drilling rigs in Texas until oil prices recover. Canadian Natural Resources planned to increase its expenditures on production in 2015, but in late 2014 announced its readiness to reduce them to 2 billion Canadian dollars if the oil and gas prices continue to fall.

At the same time, Saudi Arabia has huge oil reserves and production costs are among the lowest in the world, no more than 15-17 dollars per barrel. Many experts are unanimous in the view that the current policy of Saudi rulers primarily aims to remove the US and its offshore oil reserves from the oil market. During this struggle Riyadh feels good, because during the years of high oil prices it was able to amass impressive foreign exchange reserves, ranging according to various estimates from $750 billion to $1 trillion.

At the end of the year, Saudi Arabia formed a budget (the revenues of which consist of 89% of oil revenues) for 2015 based on an oil price of $80 per barrel, former economic adviser to the Ministry of Finance John Sfakianakis told Bloomberg news agency. The Saudi Ministry of Finance reported that the planned expenditures in the coming year will amount to 860 billion Saudi riyals (229 billion dollars), unchanged compared to expenditures in the current year. Government revenues in 2015 will amount to 715 billion riyals against the target of 1.05 trillion riyals in the current year. The deficit of 145 billion riyals is easily covered by Saudi reserves deferred “for a rainy day”.

According to one of the largest brokerage firms in Japan, Nomura Securities, in the first quarter of 2015 the price of oil will remain at $45 per barrel, in the second quarter it will rise to an average of $55, and by the end of the year it will settle for a long time at around $80.

The oil market is experiencing very serious problems when the price drop in the market is due to low demand. But now prices are falling because of a “temporary price war” which Saudi Arabia began, and is not because of declining demand, as world oil consumption is now higher than ever, analysts at Nomura Securities said.

As in 1986, Saudi Arabia is again winning this price war because the Middle East has the lowest cost of oil production in the world. For Middle Eastern oil companies, extracting a barrel of oil costs about 15-40 dollars, while half of the oil projects in the world would not be so attractive if prices remain below the level of $50 a barrel. In this regard, American oil producers have already experienced the negative effects of falling prices: since the beginning of January, the US witnessed a record decline in the number of drilling rigs, companies began to downsize and reduce budgets for 2015, said the Japanese brokerage firm.

The opinion that American manufacturers are retreating is also held by the expert Travis Hoium of the financial company Motley Fool in his article for CNN. According to him, it is unknown who the American oil companies are struggling against – traders, OPEC countries, Russia, or some kind of invisible market force, but judging from the auctions at which WTI futures are sold below $45 per barrel, while Brent is below $50, the US is losing unconditionally. And no British publications can help Washington in this regard.

Especially because the Saudi rulers are prepared to fight to the end. For example, Crown Prince Salman ibn Abd al-Aziz Al Saud addressed the Majlis al-Shura (Consultative Council, the legislative body of the country) on oil issues. Saudi Arabia will confidently overcome all the trials that have arisen due to the instability in the oil market, he read out the message of King Abdullah ibn Abdul-Aziz Al Saud.

Prince Salman spoke to members of the Council in King Abdullah’s place, as the latter was in the hospital, where he was taken on December 31 last year, and on January 2, the Office of the President announced that he had been diagnosed with a pulmonary infection. Each time after the news of the latest treatment of the monarch, either rumors of his death or a sharp deterioration in health appeared in the press.

As analysts of “Alpari” agency note, the king’s death will certainly affect oil prices. The death of the monarch could lead investors to confusion and cast the kingdom’s future policy on oil prices into doubt. All this can correct market prices upward. At the same time, Saudi Arabia has repeatedly stated that it is ready to reduce the price to $20 per barrel – to drive out of the market unprofitable offshore companies. At the same time, some experts pointed out that the death of the Saudi king is unlikely to change anything. According to Arab tradition, the throne is passed from the older to the younger brother. And now the ruler will become Prince Salman ibn Abd al-Aziz Al Saud. But he has already been effectively determining the policy of the kingdom since 2012 and the succession of the King is not likely to have a very strong impact on the politics of Saudi Arabia.

Nevertheless, Oil Minister Ali al-Naimi has repeatedly stated that in the meantime Saudi Arabia is not going to reduce the level of production of “black gold”. It is quite clear that Riyadh is playing an all-or-nothing game. Shale projects in the US, offshore projects in the Arctic and on the coast of Brazil promise an oversupply of oil in the future, and the Saudis’ judgment in starting a war now is quite sensible, while there is a chance to knock out of the game the competitors who have not brought their projects of the shale gas revolution to their logical and commercial conclusion.

Victor Mikhin, member correspondent of RANS, exclusively for the online magazine “New Eastern Outlook”.