Living the Saudi dream

Financial Mirror (Cyprus) - - FRONT PAGE -

Saudi Ara­bia wants it all: to sal­vage OPEC, achieve in­come di­ver­si­fi­ca­tion and in­dus­tri­al­i­sa­tion, and pre­serve its mar­ket share in crude oil, petroleum prod­ucts, petro­chem­i­cals, and nat­u­ral gas liq­uids (NGLs). Whether the Saudis suc­ceed will be determined largely by the shale-en­ergy in­dus­try in the United States.

The US shale revo­lu­tion di­vided OPEC ac­cord­ing to the qual­ity of its mem­bers’ crude oil. Ex­porters of light sweet crude – such as Al­ge­ria, An­gola, and Nige­ria – lost nearly all of their mar­ket share in the US, while ex­porters of sour or heav­ier crude, in­clud­ing Saudi Ara­bia and Kuwait, have lost lit­tle.

Be­cause al­most all crude oil pro­duced by the Gulf States is sour, and most of the global sur­plus is sweet, any pro­duc­tion cut by Saudi Ara­bia and its neigh­bours would not drive prices back up and re­bal­ance the oil mar­ket. The only way to do that – and pre­vent an OPEC breakup – would be to re­duce the pro­duc­tion of light sweet crude, in­clud­ing by US pro­duc­ers, which would thus lose mar­ket share. If this oc­curred, oil prices could be ex­pected to rise again rel­a­tively quickly.

If, how­ever, Saudi Ara­bia re­mains more com­mit­ted to its strate­gic devel­op­ment ob­jec­tives, low oil prices could persist. Since the 1970s, sev­eral OPEC mem­bers, led by Saudi Ara­bia, have worked to di­ver­sify their industrial base by pro­mot­ing sec­tors with a com­par­a­tive ad­van­tage, such as petro­chem­i­cals, and build­ing mega-re­finer­ies to en­able the ex­port of value-added prod­ucts. At the same time, to boost rev­enues, they ex­panded ex­ports of NGLs, which are not counted in OPEC quo­tas.

But just when th­ese coun­tries were be­gin­ning to achieve suc­cess, the US shale revo­lu­tion emerged, threat­en­ing all three of their main strate­gic ob­jec­tives. The key to the com­pet­i­tive­ness of Saudi Ara­bia’s petro­chem­i­cal in­dus­try was its use of nat­u­ral gas and ethane, which was far less ex­pen­sive than the oil prod­uct naph­tha on which its global com­peti­tors de­pended. Now that the US is pro­duc­ing mas­sive amounts of low-price nat­u­ral gas and ethane, Saudi Ara­bia’s com­pet­i­tive ad­van­tage – and mar­ket share – is be­gin­ning to de­te­ri­o­rate.

The same goes for re­fin­ing. Since the US does not al­low ex­ports of crude oil, the shale revo­lu­tion pushed down the US bench­mark price, the West Texas In­ter­me­di­ate, rel­a­tive to in­ter­na­tional crude prices, some­times with dif­fer­en­tials as wide as $20. US re­fin­ers took ad­van­tage of lower prices to in­crease their ex­ports of petroleum prod­ucts – so much so, that they are now threat­en­ing the mar­ket share of Saudi re­finer­ies in Asia and else­where.

Like­wise, US com­pa­nies have in­creased NGL pro­duc­tion con­sid­er­ably, en­abling the coun­try to slash its liq­ue­fied petroleum gas (LPG) im­ports and ex­pand its NGL ex­ports sig­nif­i­cantly. As a re­sult, Saudi Ara­bia has lost mar­ket share to US pro­duc­ers in Cen­tral and South Amer­ica.

But the re­cent col­lapse in oil prices could change this dy­namic. In re­fus­ing to cut its own pro­duc­tion, Saudi Ara­bia seems to be hop­ing that low oil prices will drive down in­vest­ment in US shale en­ergy, un­der­min­ing pro­duc­tion growth there.

Low prices may al­ready have con­trib­uted to de­lays in Amer­ica’s de­ci­sion to begin ex­port­ing crude oil, as well as to the po­lit­i­cal viability of US Pres­i­dent Barack Obama’s veto of the Keystone XL pipe­line, in­tended to trans­port oil from the Canadian tar sands to the Gulf of Mex­ico for ex­port. Add to that the de­lay in the open­ing of the Mex­i­can en­ergy sec­tor, and it seems that low oil prices could amount to a net gain for the King­dom.

Though Saudi Ara­bia’s mo­ti­va­tion in not cut­ting pro­duc­tion was prob­a­bly al­most en­tirely eco­nomic, low oil prices could also of­fer dis­tinct po­lit­i­cal ad­van­tages. Most no­tably, the decline in prices is cre­at­ing se­ri­ous chal­lenges for Iran, the King­dom’s main ri­val in the re­gion, as well as for the un­sta­ble, oil-de­pen­dent economies of Rus­sia and Venezuela. None of th­ese coun­tries has ad­e­quate sav­ings to cush­ion the blow of re­duced rev­enues.

Un­der th­ese cir­cum­stances, it seems likely that Saudi Ara­bia will con­tinue to refuse to cut oil pro­duc­tion, leav­ing prices low un­til mar­ket forces trig­ger a re­bound. And even then, the price in­crease could be limited. Af­ter all, game the­ory dic­tates that, once the sur­plus is elim­i­nated, the dom­i­nant pro­ducer must pre­vent oil prices from ris­ing high enough to cause it to lose mar­ket share again. That means that Saudi Ara­bia will try to com­pel non-OPEC coun­tries, mainly in North Amer­ica, to keep oil-pro­duc­tion in­creases com­men­su­rate with growth in global de­mand.

In short, it is in Saudi Ara­bia’s in­ter­est for oil prices to rise high enough to sus­tain its own econ­omy, but not so high that they can sus­tain sig­nif­i­cant in­creases in non-OPEC sup­ply. In or­der to keep prices in this ideal range, Saudi Ara­bia may even in­crease pro­duc­tion again.

This strat­egy is not with­out risk. In the short run, ex­ces­sively low prices could trig­ger po­lit­i­cal in­sta­bil­ity in some oil-pro­duc­ing coun­tries, driv­ing up prices. Sim­i­larly, de­lays in up­stream in­vest­ment, es­pe­cially megapro­jects, could push prices above the ideal level in the medium and long term.

But per­haps the big­gest risk lies with the US shale-oil in­dus­try. Over the next few years, US pro­duc­ers are likely to re­trench, fo­cus on sweet spots, im­prove tech­nol­ogy, re­duce costs, and in­crease pro­duc­tion once again. At that point, Saudi Ara­bia’s cur­rent strat­egy may no longer be ad­e­quate to sus­tain its mar­ket dom­i­nance.

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