Oil Prices At 6-Year Low
Yet, huge oil-producing nations continue producing more. Investors and traders may be wondering: Don’t they know that they’re only making the situation worse?
In the United States, the price of oil has plunged below $40 per barrel, while Brent trades lower than $45. Despite this, the Organization of Petroleum Exporting Countries increased their production to 31.5 million barrels per day last month.
Moreover, the output from Iraq and Saudi Arabia is at or almost at their highest in a year, and Russia ramped up its production to 10.6 million barrels per day. Currently, Russia is the biggest producer of oil in the world.
Perhaps the most straightforward explanation for the constant pumping of oil despite weak prices is that oil producers need the cash, and obviously, the lower the price of the commodity, the more they need to sell in order to sustain revenue. This idea is especially true for Russia. In 2014, as the prices of oil began to slide, it floated the Russian ruble quickly. Since then, the currency has devalued in unison with oil prices, such that every additional barrel yields similar revenue in Russian ruble, which is the currency of the budget of the government. With this, there is certainly no point for Russia to lessen their production.
In the case of Saudi Arabia, selling more oil at such lower prices makes strategic sense for them.
Just like any other oil producer, Saudi would prefer a high price for its commodity. However, because it is a wealthy country and has massive reserves, it is more concerned with the long-term.
Seeing the oil output of the US nearly double within the past 7 years, largely because of the boom in US shale production, the Middle Eastern country realized that there is a possibility that it will lose its role as the “swing producer,” which can control the price direction by boosting or cutting its own production.
Saudi thinks that in order to keep the role, it has to drive the US shale producers out of business. In the world of oil producers, the costs of production are kept secret and Saudi Arabia believes that the process of fracking that US shale producers implement is highly expensive.
Hence, Saudi Arabia came up with the strategy of keeping its levels of output high to push the price of oil down. The logic behind this is that if the oil price stays low at a long enough time, high-cost producers will be adversely affected and will eventually shut down. Once the rivals had been forced out of the picture, Saudi Arabia can easily boost the prices by cutting down its production, and will once again earn huge profits.
Although the country is losing money too, and 90 percent of its budget comes from oil revenues, it can live on its savings for a while.
Several shale producers in the United States have already decided to delay new drilling projects, but they have integrated into bigger companies and improved the efficiency of their processes. Thus, the growth of US oil production is in fact continuing this 2015 and the output is already around 90% of Saudi Arabia’s.
It appears like Saudi has made a huge mistake of overestimating the production costs of US shale oil and thought that a price lower than $80 a barrel would be unprofitable. Though this may be true for some, the costs vary widely, depending on geological factors. The majority of US shale oil is profitable at around $60 per barrel.
Furthermore, the Middle Eastern country failed to consider that when you stop production from a traditional oil well, there is a huge and almost permanent loss of flow when you recommence production. The reason behind this is that oil-bearing rocks’ pores will be clogged and will result in a weaker bottom-hole pressure, which pushes the oil to the surface.
On the other hand, cutting production at a shale site does not induce loss, since the producers are the ones which inject pressure. Therefore, restarting production is much easier for frackers and the flow will be just the same as before.
Even if Saudi Arabia succeeded in pushing shale producers to shut down, the frackers could easily get back into production as soon as the Middle Eastern country cut its production to make oil prices surge.
It might take a while for Saudi to realize its mistake and US oil production will continue to rise. By next year, Iranian oil will flow back into the global markets and though Saudi Arabia will stay rich, it will suffer from loss of influence.