LONDON (Reuters) - Saudi Arabia’s strategy for rebalancing the oil market through a period of lower prices shows few signs of working so far - with rival producers claiming they will raise output even as prices slide to new lows.
Saudi policymakers insist the kingdom will maintain its market share and let low prices take care of the surplus by forcing cuts from higher cost producers and stimulating fuel demand.
With prices down by more than half compared with the same point in 2014, oil consumption is growing at some of the fastest rates for a decade.
There are signs output growth from shale drillers and other producers outside OPEC is starting to slow, but it is not falling yet.
Within OPEC, other producers, principally Iraq and Iran, are determined to continue raising their output even as prices slump.
“We will be raising our oil production at any cost and we have no alternative,” Iran’s Oil Minister Bijan Zanganeh said in a news story carried on his ministry’s website.
“If Iran’s oil production hike is not done promptly, we will be losing our market share permanently,” Zanganeh added.
Saudi Arabia’s strategy may not be enough to eliminate the surplus and lead to a sustained rise in prices in the next two or three years.
The resilience of non-OPEC output despite slumping prices, coupled with a continued battle for market share within OPEC itself, contributed to the “lost decade” in oil markets after 1986.
Oil producers and investors fear the same stalemate could be playing out again.
“It is not the role of Saudi Arabia, or certain other OPEC nations, to subsidize higher cost producer by ceding market share,” Oil Minister Ali Naimi told an audience in Berlin in March.
“Saudi Arabia is called upon to make swift and dramatic cuts in production. That policy was tried in the 1980s and it was not a success. We will not make the same mistake again.”
The Saudi calculation appears to be that as a low-cost producer with massive financial reserves and almost no debt, the kingdom can ride out an extended period of low prices better than most others in the market.
Once higher cost and financially weaker producers have been forced to cut their production, prices will rise and Saudi Arabia will benefit from a combination of higher prices and successfully defended market share.
The problem is that there are so far few signs of non-OPEC output actually falling and other OPEC countries are currently trying to increase, not restrict, their output.
According to the U.S. Energy Information Administration, shale production is already dropping and will continue falling through the rest of the year and into 2016 unless prices recover (“Short-Term Energy Outlook” August 2015).
EOG Resources, one of the largest shale producers, expects output will turn down in July and August and the rollover should be evident when the data is published in September and October, which would vindicate Saudi thinking.
But other shale producers, such as Pioneer, are more bullish, and claim they will be able to continue increasing output in the second half of 2015 and through 2016 even at depressed prices.
Production records from North Dakota show output stalling but still near its peak of 1.2 million barrels per day (bpd).
Some reduction in output is also likely to come from non-OPEC non-shale producers with conventional projects in Latin America, Africa, the North Sea and other parts of the world.
Major international oil companies and leading independents have all announced sharp cuts in their exploration and production budgets which should in theory translate into lower production over time.
The number of rigs drilling in the non-OPEC non-shale segment of the market has fallen by more than 20 percent since July 2014, according to rig counts published by Baker Hughes.
The International Energy Agency predicts non-OPEC supply will be essentially flat in 2016, after growing by 1.0 million bpd in 2015 and 2.4 million bpd in 2014.
But non-OPEC growth, from both shale and conventional producers, could prove more resilient than Saudi Arabia, OPEC and the IEA have assumed, in a replay of the 1980s.
LOST DECADE AGAIN?
“I just cannot understand how this low price can sustained investment in high-cost oil areas, someone somewhere must be losing his shirt,” former OPEC secretary-general Ali Jaidah told a closed conference in 1988.
“Saudi Arabia believes that the price war eventually will eliminate much oil from non-OPEC producers, such as Britain and the United States, because their oil is too expensive to produce,” the Wall Street Journal wrote in 1986. The exit of this oil would make more room for OPEC production growth.
But while non-OPEC production stopped growing for four years after 1985, it defied expectations it would fall, and started rising strongly again in the early 1990s (link.reuters.com/qax45w).
MIT economist Morris Adelman explained: “The shock of the oil price chilled investment. Non-OPEC production barely increased from 1985 to 1992. But its failure to decline was a great disappointment.”
One reason production failed to decline was lower prices stimulated a drive to make production much more efficient, including the first widespread use of three dimensional seismic surveys and horizontal drilling (“The Cartel in Retreat” 1993).
Meanwhile OPEC struggled to restrict its own supply. Saudi Arabia insisted on maintaining its share of cartel production while other countries, including Iraq, Iran, Kuwait and the UAE all sought to increase theirs.
Everyone wanted market share, while expecting someone else to cut production in order to support prices. The result was an endless and self-defeating increase in OPEC output.
For almost 20 years, experts predicted demand growth, coupled with a slowdown in non-OPEC supply, would enable OPEC to increase output, eliminate excess capacity, and push prices much higher.
But it never happened. Not until 2003 did oil prices move sustainably above the level to which they had fallen in 1986 and 1987 in real terms.
VINDICATED AT LAST?
There are key differences between 1986 and the oil market today. In 1986, there were estimated to be 6 million barrels per day of spare capacity shut in among OPEC members, compared with less than 2 million currently.
But there are also echoes, including Saudi Arabia’s insistence it will not cut production, attempts by Iran and Iraq to boost theirs, and the resilience, so far, of non-OPEC output in the face of slumping prices.
Saudi Arabia’s strategy could yet be vindicated. It takes time for a price crisis to work through to changes in production and consumption.
There are lags in the production data. Output from shale producers and the non-OPEC non-shale sector could already be falling even though it is not evident in the official numbers yet.
Demand is growing strongly, especially in the United States, though doubts are emerging about that too, as China’s economy sputters.
Low prices could yet force bankruptcies in the U.S. shale sector or voluntary cuts in production, and they will certainly concentrate minds within OPEC.
If prices fall low enough for long enough it will force some sort of crisis in the market, as happened at various times after 1986, and a rebalancing, at least temporarily.
But hopes that Saudi Arabia can force a swift realignment of supply and demand without years of pain for all oil producers are evaporating.
Editing by William Hardy
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