It’s time investors faced oil’s free fall
Saudi’s won’t turn down taps anytime soon
“T hat is not going to happen.”
Thus spake Ali Al- Naimi, Saudi Arabia’s oil minister, to a group of industry executives gathered in Houston earlier this week.
The “that” he was referring to is the idea of a cut in oil production by Saudi Arabia, which has been the subject of a good deal of speculation in media and markets lately.
Some of that speculation has been fuelled by rumours and tall tales. Some of it is just wishful thinking. And some is based on a seemingly logical view of the costs of low oil prices to the Saudi Arabian economy.
After all, the world’s largest producer must be bleeding money, right? It’s got cushy social programs to pay for, not to mention an expensive royal family. It’s been dipping into its cash reserves with oil at US$ 30 a barrel. Heck, it even had its credit rating downgraded by Stan- dard & Poor’s recently.
Just how long can Saudi Arabia hold out before it has to turn down the taps?
Well, apparently, the answer is forever. So that settles “that.” This is not the kind of thing energy investors will like to hear. It might not be the kind of thing any investor likes to hear. But at least it is reality — or as close to it as we are likely to get in the wacky world of petro-political communications.
The Saudi oil minister was just as categorical when it came to how higher-cost producers should address the challenge of low oil prices: if they can’t stand the heat, get out of the oilfield.
The Saudis aren’t going to subsidize higher-cost producers by limiting their own low- cost production. Not anymore.
In a Q& A following his Houston speech with energy scholar Daniel Yergin, AlNaimi mentioned what Saudi Arabia was going to do instead: “Let everybody compete,” and, “Follow the marginal cost curve.”
Which is a wonderful strategy if you’re Saudi Arabia and have the lowest production costs of any major oil producer. Even at US$20 a barrel, the Saudis can cover their marginal costs.
Al-Naimi also didn’t seem overly enthusiastic about the potential deal among Saudi Arabia, Russia, Venezuela and Qatar to hold oil production at current levels.
Remember, this isn’ t a deal yet — not until other producers agree to it. And Iran, for one, clearly isn’t about to do that.
Still, the four countries that might agree to freeze production will “hopefully” be meeting with other producers next month, according to Al- Naimi. In the meantime, “there is a lot of talk.”
Even if the world magically holds production at current levels, it mightn’t do anything to lift oil prices. Current production is outpacing demand. And where would you put the ceiling on individual producers’ output? Last month, when Iraq pumped a record amount of crude, and when Iran ramped up?
The International Energy Agency estimates that at current Organization of the Petroleum Exporting Countries production levels, global oil stocks will build by two million barrels per day in Q1 and 1.5 million barrels per day in Q2, before moderating to below one million bpd in the second half.
Given all that, investors should be feeling pretty confident that no supply constraint is going to descend from heaven and raise oil prices anytime soon.
But what about the other side of the equation — demand? Market logic suggests that demand growth will eventually catch up with production, and prices will recover.
The question is when. In Houston, Yergin asked Al-Naimi for his best guess. “If I knew that,” he answered, “you and I would go to Las Vegas.”
Gambling is illegal in Saudi Arabia, by the way, and forbidden by the Koran. But no matter, we get Al-Naimi’s drift.
The Saudi minister said that demand for oil remains strong. It’s true that growth in demand is slowing, largely as a result of China’s more slowly growing economy. But that is not negative growth. And when it comes to demand, there are some signs of hope.
Since November 2014, when oil began its free fall, total vehicle miles travelled in the United States has increased by nearly four per cent, surpassing 2007 peaks, according to data from the U.S. Highway Commission. That means, in short, Americans are driving more. Gasoline consumption in the States rose by 2.6 per cent last year, reaching ( again) the highest levels since 2007. Meanwhile, in the world’s biggest auto market — China — car sales climbed nearly 10 per cent last month.
The point is, maybe it’s time for investors to put aside false hopes. A revival in oil prices is not around the corner.
Instead, maybe we should adapt and consider opportunities among those that benefit from cheap crude: U.S. consumers, China’ s fastgrowing middle class, as well as net oil importing regions both developed (Japan, Europe) and developing ( Thailand, India, Turkey).
The world-according- toAl-Naimi may well be unfolding more or less the way it should. We might as well get used to it.
WHEN IT COMES TO DEMAND, THERE ARE ... SIGNS OF HOPE.