It's possible that the Saudi strategy includes affecting American oil production. But from what I've read the true targets are Russia and Iran.
Iran is the main rival of Saudi Arabia in the Middle East. Russia is the main ally of Iran, and supplies crucial financial support. Much of the income received by the Russian economy comes from the export of oil. In turn Russia uses the profits from those exports for political purposes around the world.
So, in a nutshell, the Saudi plan is to cut off income to the Russians through the lower price of oil. By doing so the Saudi's believe Russia will have less money to help Iran. Plus, much of the income that fuels the economy of Iran comes from oil sales.
To be sure there will be a down turn in development of the shale deposits in the U.S.; but it won't stop. There are other factors that will keep development moving forward, and may even cause a rise in the price of oil. In fact T. Boone Pickens, among others, are predicting $90.00/bbl oil by the end of 2015.
So in the end the Saudi's will lose.
The future is the future. And my crystal ball is opaque this morning. So who knows what's ahead.
But the Russkies are surely in a world of hurt right NOW!
Is Saudi Arabia Targeting U.S. Shales?
There is no shortage of interpretations in the financial and general interest media as it relates to the recent oil price collapse. One frequently mentioned explanation attributes the decline to Saudi Arabia's deliberate strategy to target U.S. shale production as the most threatening source of supply growth. While this simplistic formula seems to work well for journalists, it contains little economic logic and presents a distorted picture of competitive dynamics in the global oil market.
Due to the size of the resource base and the pace of growth, North American tight oil production is indeed a formidable competitor to other sources of crude supply, including Saudi Arabia. However, for a number of structural reasons, specifically targeting U.S. oil shales is unlikely to be Saudi Arabia's strategy. Moreover, I would argue that the North American shale oil industry will likely emerge as one of the biggest strategic winners once the current oil price downcycle has run its course.
The reason why Saudi Arabia is unlikely to be singling out North American tight oil as its target is simple - in terms of cost, U.S. shales are not the marginal supply source and such strategy would be unlikely to work.
At this point, North American shale industry is essentially indestructible, in my opinion (barring emergence of a disruptive energy technology). Even if Saudi Arabia were successful in halting drilling activity in North American shales by sending a strong price signal, the slow-down would only be temporary, with growth resuming almost immediately after oil prices are allowed to recover. In other words, the strategy would be costly but ineffective.
There is no doubt that the current sharp decline in oil prices is dealing a heavy blow to shale operators in the near term. Spending cuts will continue to be announced; cash flows will show unflattering year-on-year comparisons; production growth will slow down; some operators may even go out of business or lose some of their assets. None of this, however, will be unique to oil shales and none of this suggests that the shale oil industry is going away.
Moreover, even in a severe downcycle, drilling will likely continue in the most prolific shale sweet spots, providing continuity of the industry's learning curve. Technical knowledge and productivity improvements will continue. The downcycle would also force the industry to adapt its cost structure to the new price environment that is no longer all-forgiving. The bottom line - shale plays may see their footprints shrink, but will emerge with an even more competitive cost of supply.
After a decade of technical progress, a large number of prolific shale oil plays with a vast combined resource in place have been discovered, evaluated and, in many cases, thoroughly delineated. A tremendous amount of infrastructure has been put in place. Extensive play-specific technical knowledge has been accumulated. Even if the pace of drilling slows down, those resources will remain in the ground, ready for extraction once the commodity price is "right." I should note, the "right price" is a steadily declining target.
Another critical component of shale oil's viability in North America is the industry's mighty and flexible operating capacity. This capacity is not limited just to the fleet of fit-for-purpose drilling rigs and extensive oilfield service infrastructure in place. It includes a formidable corps of oil and gas professionals, thousands of companies linked by operating relationships, cutting-edge technology, established framework of mineral rights ownership, strongly protected property rights, stable and transparent legal environment, vast delivery and processing infrastructure, highly effective financing channels, favorable taxation regime, proximity to the destination market, etc. This productive capacity may become underutilized during the downcycle, but it is not going away overnight. As demonstrated by the meteoric rise of shale oil production in the past several years, in an upcycle this capacity will be mobilized quickly and deliver very impressive results.
In addition to the relatively low F&D cost per barrel within sweet spots, North American shale oil industry has another important advantage relative to many other supply sources: it is less capital-intensive.
Shale oil is characterized by relatively short capital cycles. In fact, the greatest capital outlays relate to the retention, evaluation and delineation phase for new resource plays and infrastructure installation to accommodate growing production streams. In several important oil resource plays in the U.S. and Canada - such as the Bakken, Eagle Ford, Permian and Niobrara - such investments either have already been made or are well underway.
In the full development phase, it may take as little as a few months from a capital investment decision to first production. Moreover, due to steep initial production declines, a new well often has full payback in one to three years.
Compare this to ultra-deepwater or international mega-projects that can consume five to ten years (or even longer) and many billions of dollars in development capex before first oil. Add to that the risk and cost of political instability, expropriation and corruption that are sometimes associated with non-OECD jurisdictions, or environmental and operating risk in ultradeepwater or harsh environments, and the cost-of-capital comparison is clearly in favor of simple, predictable and politically riskless shale plays.
As a result, shale oil operators can respond to a price signal with a production increase much faster than most of their non-shale competitors and are likely to gain market share in the upcycle, effectively at the expense of mega-projects that have much longer lead times.
In this context, it would appear that higher-cost and less flexible sources of supply would be more vulnerable to hypothetical pro-active steps by Saudi Arabia aimed at curtailing capacity growth. North American shales, on the other hand, would effectively benefit from the market share loss by marginal suppliers.
Saudi Arabia is often credited with the ability to influence, if not define, the price of crude oil. Some of the recent statements by Saudi officials indeed seem to indicate that the Kingdom has a determined view on the structure of global oil supply and demand and necessary course it needs to follow in the current environment. However there is no clear evidence that Saudi Arabia is currently using pro-active supply initiatives to influence oil prices and is not just a price taker like everybody else, also surprised by the magnitude of the commodity price move.
The circumstance that Saudi rhetoric regarding its determination to protect its market share coincides with the rapid decline in the price of oil does not necessarily mean that Saudi Arabia is proactively "piling on" barrels in order to depress prices. By the same token, the fact that Saudi Arabia and other OPEC members point in the direction of North American shale oil production as a source of oversupply does not mean that shale oil is being targeted by any sort of policy.
Having said that, one could speculate that a proactive approach would make a tremendous sense for Saudi Arabia and OPEC as a whole in the current situation. In an oversupplied market, pro-actively adding supply - even in small volumes - would collapse the price. In this sense, such strategy could be very effective (and its execution would be almost undetectable to the market).
Furthermore, Saudi Arabia and its key GCC allies have sufficient spare capacity and, importantly, financial resources to maintain the price of oil at a low level for a period of time that would be sufficient to induce a tangible and lasting behavioral response from the industry.
From OPEC's perspective, the most valuable outcome of such a "shock and awe" strategy would be the postponement of many mega-projects and investor risk aversion.
While OPEC does not need to target any specific source of supply to extract a strategic benefit from a hypothetical "shock and awe" strategy, the price decline may nonetheless trigger a shake-out among weaker competitors.
Low oil prices have already put some oil revenue-dependent countries on the brink of an economic crisis. Russia is a vivid example. The world's largest oil producer is likely to dive into a deep recession in 2015. In an environment when avoiding hyperinflation and a run on the banks is the existential priority, investment into capital-intensive oil developments and technology is likely to come to a halt, almost inevitably leading to a lasting decline in oil production.
In Russia's specific case, the impact of the low oil prices is effectively amplified by the overall structural weakness of the country's economy and institutional setting. The cyclical downturn in oil triggers a much broader economic avalanche that in its turn creates a highly unfavorable operating environment and inefficiency that undermine the country's long-term productive capacity in oil (and natural gas, due to oil-correlated pricing).
Another category of producers that could potentially sustain long-term damage from this downturn are Oil Majors, such as ExxonMobil (NYSE:XOM), Chevron (NYSE:CVX), bp (NYSE:BP) and Total (NYSE:TOT). Oil Majors' competitive advantage and business models have been based, among other things, on these companies' ability to underwrite multi-billion mega-projects in technically challenging or politically environments (such as the Arctic, ultradeepwater, pre-salt, emerging economies, etc.). This is the category of supply sources that may lag in terms of their market share behind the less costly and more reliable sources of oil supply, such as shale oil (and, increasingly, oil substitutes - natural gas, electric vehicles, etc.).
While in theory Oil Majors have a superb opportunity to leverage their strong balance sheets to buy into shale oil assets at attractive prices, the experience of the past decade indicates that Oil Majors have so far been behind the curve in capturing shale opportunities. Most importantly, the Majors have proved unable to adopt the low-cost, entrepreneurial institutional culture that is required for success in shale oil.
Shale oil is a new but unavoidable reality that conventional producers - including OPEC and Oil Majors - will have to learn to co-exist with (and set their price expectations accordingly).
The downcycle may in fact make the shale oil industry stronger and more competitive, positioning it for further market share gains.
Ultimately, the introduction of reliable, abundant, and relatively low-cost source of supply - shale oil - results in a lower long-term price of oil expectation. It also erodes OPEC's supply monopoly.
Consumers are the ultimate winners.
Good article, thanks for posting that. I like the Seeking Alpha articles but SA ends up sending all kinds of email.
take a "few truths " & expand greatly the conversation from there---Bakken, Eagle Ford et al , pay-back in 1 to 3 yrs--correct @ $105 oil, new oil, unhedged @ $55, same pay/back -NO WAY !!!--rig rates of $25 k per day do not go down to 12.5 k , they start sitting idle---look @ the decrease in permit applications, & the weekly decrease in oil rigs working,esimated to decrease by 25% or more by mid/2015---about 1950 now going to 1400---& now the big point, if your proved, producing & unproved reserves are halved , pls tell me how you can borrow $$$$ for capex for drilling in the future ??---the Saudis & allies know exactly what they are doing,--stop any thought of the US ever becoming a net exporter of unrefined crude oil, & to the point of " cheap oil "--1900ss--oil from macksberg/ Ohio , price $1 per barrel,--" Loaf of Bread ", $ .01---
Very true Trapper. It's time for the US to set the price.
It was bound to happen as we have been their main customer.
I am with you on domestic energy though. If we would/could set our own pricing it would be great. Truth is though, we'd have to rely solely on North American production 100% for this to work. As of now, and possibly moreso in the future, our pricing is based on global demand & production. We will always be "slaves" to global energy prices as long as we are an importer *or exporter. Seems like we're in a big damned hurry to put our domestic consumers in price competition with global markets by exporting our newfound inexpensive energy.