Dangerous tactic

Saudi Arabia’s response to falling crude oil prices appears to be one of “toughing it out”, but this strategy could backfire on them.

The world has been watching for a response from OPEC and Saudi Arabia in particular, as crude oil production continues to ramp up, thanks to the huge increases in USA domestic shale oil production. Now it appears clear that the Saudis will not defend prices by cutting production. They have increased some regional prices, but generally allowed the price to slide. It appears that the game is to let US shale oil producers feel the pain of low prices, and perhaps force some out of business.  The theory goes that shale oil is more expensive to extract, and the capital costs higher. Low prices will make it less attractive to invest or operate in shale oil plays.

But that tactic is a dangerous one.   It ignores several important factors.

First, not all shale oil plays are the same.   The rates of return in some Permian Basin plays are very attractive, even down to a crude oil price of $40, though of course the payback period becomes longer.

Second, shale oil producers are already seeking out the best plays, and a lower price simply increases the imperative.

Then there is the fact that a rig once started will continue to produce. Multiply that by the hundreds or thousands of rigs in any single field, and you get an effect that oil production remains strong long after people have stopped investing in the field.

Finally, the USA is just the first country to accelerate shale oil production.  There are plenty of other countries who will see a national and strategic benefit to having their own domestic production, and becoming less dependent on OPEC oil.

The Saudi could find themselves in a situation where they are losing profits now, and market share later.

Hat tip the the RBN Energy blog for some of the information here.


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