Mission & Name
US Foreign Policy (Dr. El-Najjar's Articles)
Oil Price War May Benefit Both US Shale And
By Michael McDonald
Oil Price, Al-Jazeerah, CCUN, April
Even as financial commentators on CNBC are starting to
come around to the idea of a
bottom in oil prices, the key question for US oil producers remains one of
timing. How long will the oil price slump last? Is this a relatively short
term event like 2008, or a
longer term slump like the one in the mid 1980’s? After the oil price
crash in 1985, it took almost twenty years for prices to revert to previous
levels. If oil does not return to $100 a barrel until 2035, there will be a
lot less shale companies around. Some market commentators have cited hedging
as a potential source of safety for oil producers, but the truth is that
given most firm’s individual levels of hedging and the price of oil today,
the hedges are more of a Band-Aid over a gunshot wound than anything else.
The US shale oil industry faces an implacable foe in the current
crisis: Saudi Arabia. The long-time king of the oil markets is probably the
most responsible for the current price decline, and probably the party
that is happiest about it. Saudi Arabia is uniquely positioned to withstand
low oil prices given that inside sources say
the country has nearly $800B in reserves to weather the storm.
Early on in the fight, shale oil companies were loudly proclaiming
their ability to withstand low prices, but those statements have dimmed
in intensity and frequency in recent months. At this point, Saudi Arabia’s
currency reserves are roughly equal to the combined market capitalization of
the entire US shale oil industry.
The fundamental equation that
drives any country or company’s ability to survive in the oil industry is:
(Oil Price per Barrel – Cost Per Barrel)*Barrels Produced + Cash Reserves >
Essentially if a firm or country has a cost of extraction that is
greater than the price per barrel they receive, then they can only produce
until their cash reserves run out. Most analysts estimate that cost per
barrel for US shale companies
ranges from the mid-fifties to the low nineties. That means, at this
stage, almost none of the US shale oil producers are going to be making
money producing. These costs have obviously fallen in the last six months as
producers look to modify contracts with suppliers and subcontractors and
generally push down costs anywhere they can.
Analysts have varying
views on the cost of production for Saudi Arabia with some citing total
costs above $80 and others suggesting
costs as little as $5 per barrel. Regardless, it is likely that Saudi
Arabia’s costs are lower than that of the US oil producers and their cash
resources are certainly greater.
The life raft for US oil producers
so far has been its hedging at higher prices.
Bloomberg recently cited $26B in oil price hedges, which certainly helps
to buy US oil producers time. Ultimately though, oil is not profitable at
today’s levels for US oil producers and this is what has driven the falling
rig count in recent weeks.
In the end, who will win the oil price
battle, Saudi Arabia or US capitalism and shale producers? Probably both; US
oil producers are taking unparalleled steps to lower their costs which will
result in much more efficient operations in the end, similar to how US
manufacturing came out of the Great Recession at high levels of productivity
and ultimately profitability. By the same token, Saudi Arabia is the king of
the oil markets for a reason – geologically it is essentially the perfect
oil producer. The real losers in this fight are likely to be the other
participants who have been trying to stay out of the conflict as much as
possible. Other OPEC producing nations and even Russia are not as efficient
as Saudi Arabia, nor as dynamic as US shale producers. And ultimately, they
are likely to be the ones forced to give ground and cut production.
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