It’s time in­vestors faced oil’s free fall

Saudi’s won’t turn down taps any­time soon

National Post (Latest Edition) - - FINANCIAL POST - An­i­mal Spir­its Joe Chi­d­ley Fi­nan­cial Post

“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.

F. CARTER SMITH / BLOOMBERG

Ali Al-Naimi, Saudi Ara­bia’s pe­tro­leum and min­eral re­sources min­is­ter, told at­ten­dees of the 2016 IHS CERAWeek

con­fer­ence in Hous­ton, Texas on Tues­day that Saudi Ara­bia isn’t about to cut oil pro­duc­tion.

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