In early 2019, Sau­di Ara­bia re­vea­led it is going back to mo­dif­ying oil pro­duc­tion vo­lu­mes to in­fluen­ce cru­de pri­ces. Thus, it re­turns to its tra­di­tio­nal mar­ket con­trol met­ho­do­logy and abandons the pri­ce war laun­ched in 2014. What can we learn from this pro­cess that cau­sed up­hea­val in the world four years ago?


The peak oil hap­pe­ned ap­pro­xi­ma­tely in 2006. The phe­no­me­non, ho­we­ver, did not re­fer to all oil, but rat­her con­ven­tio­nal oil, al­so known as easy oil.

This con­ven­tio­nal oil is ex­trac­ted ons­ho­re or in sha­llow wa­ter pro­jects. The term al­so re­fers to oil with nor­mal vis­co­sity or API gra­vity le­vels, not ex­tra heavy oils that are dif­fi­cult to ex­tract.

On­ce the awai­ted peak had arri­ved, oil pri­ces be­gan a sus­tai­ned ri­se. With the ex­cep­tion of the 2008 fi­nan­cial cri­sis, the Brent ba­rrel main­tai­ned pri­ces of over $75 prac­ti­cally sin­ce 2007, stan­ding clo­se to $110 in 2012-2014.

The­se high cru­de pri­ces, with fo­re­casts they would main­tain over ti­me, crea­ted two phe­no­me­na in the energy sec­tor. On one hand, in­vest­ment in re­ne­wa­ble ener­gies in­crea­sed ex­po­nen­tially as they gai­ned com­pe­ti­ti­ve­ness com­pa­red with oil and ot­her re­la­ted com­mo­di­ties.

On the ot­her hand, oil ope­ra­tors tur­ned their sights to un­con­ven­tio­nal ex­plo­ra­tion and pro­duc­tion sour­ces, which we can di­vi­de in­to se­ve­ral ty­pes: • Oil ob­tai­ned in deep wa­ters and ex­tre­me te­rri­to­ries such as the Ar­ctic. • Oil ob­tai­ned th­rough

fracking or tight oil. • Ex­tra heavy oil li­ke the one ex­trac­ted from Ca­na­da’s oil sands and the Ori­no­co Belt in Ve­ne­zue­la. • Na­tu­ral gas con­den­sa­tes. • Bio­fuels ob­tai­ned, for ins­tan­ce, from corn or su­gar­ca­ne. Whi­le the­re are a lar­ge va­riety of ca­ses, un­con­ven­tio­nal cru­de ex­trac­tion is pro­fi­ta­ble with oil pri­ces of over $40 or $50 per ba­rrel.

And it was pro­fi­ta­ble. From the in­vest­ments in Bra­zil’s Pre­salt and Ca­na­da’s hu­ge open-pit mi­ning ope­ra­tions to pricy fracking tech­ni­ques in the Uni­ted Sta­tes, the un­con­ven­tio­nal sec­tor pro­gres­si­vely gai­ned mar­ket sha­re. Un­con­ven­tio­nal cru­de ex­trac­tion al­so gai­ned re­le­van­ce, to the ex­tent that world­wi­de oil re­ser­ves ha­ve only in­crea­sed over the past 10 years.

Ex­xo­nmo­bil’s Outlook for Energy 2018 in­di­ca­tes that the con­ven­tio­nal cru­de sha­re is de­crea­sing whi­le un­con­ven­tio­nal sour­ces con­ti­nue to grow.

It was the days of wi­ne and ro­ses for the oil in­dustry. With pri­ces that ran­ged from $5 to $25 per ba­rrel, con­ven­tio­nal oil pro­du­cers ob­tai­ned hu­ge be­ne­fits. Two ma­jor pro­du­cing nations, Nor­way and Sau­di Ara­bia, used their oil re­ve­nue to crea­te mul­ti­mi­llion pu­blic in­vest­ment funds. The in­dustry even grew in coun­tries with a weak oil tra­di­tion, such as Co­lom­bia. In Ve­ne­zue­la, the cha­vis­ta go­vern­ment found a con­si­de­ra­ble flow of do­llars to fi­nan­ce its Bo­li­va­rian re­vo­lu­tion. And in the Uni­ted Sta­tes, rail­ways across the country we­re over­crow­ded due to the trans­por­ta­tion of the si­li­ca sand re­qui­red for fracking ope­ra­tions.

Everyt­hing see­med per­fect un­til in 2014 an analyst at Sau­di Aram­co pre­sen­ted the com­pany’s re­cent sa­les sta­tis­tics to the Board of Di­rec­tors. The board is com­pri­sed of a group of exe­cu­ti­ves, all men - that in­clu­ded se­ve­ral wes­ter­ners, for­mer ma­na­gers of the World Bank, Shell, and BG -. The­se men sha­red the ta­ble with their Arab co­llea­gues, nor­mally dres­sed in thawb and per­fectly alig­ned with their friends and fa­mily in the go­vern­ment, in­clu­ding pres­ti­gious oil mi­nis­ter Ali al Nai­mi.

Board mem­bers con­fir­med, th­roug­hout se­ve­ral months how sa­les to one of the com­pany’s big­gest cus­to­mers, the Uni­ted Sta­tes, drop­ped sig­ni­fi­cantly, going down by 25%. In ot­her mar­kets, such as Asia, they stood strong thanks to the re­gion’s dy­na­mism and Chi­na’s re­lentless growth.

What hap­pe­ned was that the Uni­ted Sta­tes’ pro­duc­tion, far from de­cli­ning as had been fo­re­cas­ted years ago, was gro­wing strong thanks to fracking and its tight oil and con­den­sa­te pro­duc­tion.

At that mo­ment, the sa­les de­cli­ne mainly fo­cu­sed on North Ame­ri­ca, whe­re the in­dustry’s tre­men­do­us strength and the fi­nan­cial mus­cle that sup­por­ted fracking had ma­na­ged to greatly in­crea­se pro­duc­tion. But the Board had one doubt: could the mar­ket sha­re loss ex­pand to ot­her re­gions?

Per­haps the ti­me had co­me to curb the un­con­ven­tio­nal pro­duc­tion ri­se and, by doing so, smash a fist on the ta­ble.

Up to that point, oil pri­ces had been con­tro­lled th­rough a supply ma­na­ge­ment tac­tic hand­led th­rough the OPEC. Oil de­mand is very inelas­tic: it is in­con­cei­va­ble that an oil re­fi­nery could run out of raw ma­te­rial, and oil pro­du­cers need to sell their oil at all costs, gi­ven that they can only sto­re a certain amount. Hen­ce, a slight va­ria­tion in pro­duc­tion or stocks cau­ses sig­ni­fi­cant chan­ges in the pri­ce.

And Sau­di Ara­bia just so hap­pens to be the na­tion with the grea­test in­fluen­ce in pro­duc­tion shifts, as it has lar­ge re­ser­ves at a low cost, a clearly po­si­ti­ve ex­port ba­lan­ce, and con­trols pro­duc­tion with a sin­gle com­pany. The ro­le of a swing pro­du­cer is a than­kless one be­cau­se it ce­des mar­ket sha­re in or­der to main­tain the pri­ce and, mo­re of­ten than not, the rest of the OPEC pro­du­cers do not strictly comply with the pro­duc­tion cut deal.

But in 2014, partly stem­ming from geo­po­li­ti­cal fac­tors such as the ri­sing con­flict in the Midd­le East, the fear of a quick re­co­very of Ira­nian pro­duc­tion, and so­me pro­du­cers’ re­luc­tan­ce to cur­bing pro­duc­tion at such a sweet mo­ment, the Sau­dis de­ci­ded to do things dif­fe­rently. In or­der to ef­fec­ti­vely cut off com­pe­ti­tion from new pla­yers, Aram­co dras­ti­cally re­du­ced its sa­les pri­ce. That is to say that it did not al­ter supply by ram­ping up pro­duc­tion. It simply star­ted a pri­ce war by re­du­cing the lis­ted pri­ce that Aram­co dis­tri­bu­ted to clients. Mi­nis­ter Ali al Nai­mi said at a con­fe­ren­ce in Ger­many “it is not the ro­le of Sau­di Ara­bia, or certain ot­her OPEC nations, to subsidize hig­her cost pro­du­cers by ceding mar­ket sha­re.”

And it un­doub­tedly suc­cee­ded in ta­king the pri­ce drop to the mar­ket, which went from $110 in 2014 to just $50 in 2015 and slightly over $30 in 2016.

The pri­ce drop spar­ked a ca­taclysm th­roug­hout the oil sec­tor and par­ti­cu­larly un­con­ven­tio­nal cru­de pro­duc­tion. Lar­ge pro­jects we­re hal­ted all over the world, first in a slow and pru­dent man­ner and fi­nally across the board. Shell can­ce­led its ex­tra­or­di­nary and su­per ex­pen­si­ve Ar­ctic pro­ject in nort­hern Alas­ka; the Gulf of Me­xi­co saw the in­te­rrup­tion of the deep wa­ter pro­jects, and the U.S. fracking sec­tor pa­raly­zed many of its dri­lling rigs, lo­sing one thou­sand in


just one year. The ma­jors re­vie­wed their pro­gram ma­na­ge­ment po­licy and the en­ti­re sec­tor ma­de bru­tal staff re­duc­tions, dis­mis­sing mo­re than 200,000 wor­kers in a little over two years.

Sau­di Ara­bia’s oil mi­nis­ter in­di­ca­ted that the country nee­ded to ma­na­ge the transition to­ward an eco­nomy that is less re­liant on oil, but it must do so whi­le con­tro­lling the bu­si­ness. The words of for­mer co­lor­ful oil mi­nis­ter, Sheikh Ya­ma­ni re­soun­ded on­ce again: “the Sto­ne Age did not end for lack of sto­ne, and the Oil Age will end long be­fo­re the world runs out of oil.” Sau­di aut­ho­ri­ties stres­sed the re­ser­ves funds suf­fi­ced to com­pen­sa­te for the lo­wer re­ve­nue.

In 2015 and 2016, Sau­di Ara­bia’s GDP sharply drop­ped, leading to a fis­cal de­fi­cit in this country whe­re 45% of the eco­nomy de­pen­ded on oil. Sau­di Ara­bia has 32 mi­llion in­ha­bi­tants, no va­luead­ded tax, a lar­ge part of the po­pu­la­tion re­cei­ves sub­si­dies, and has very little in­dus­trial pro­duc­tion of its own. The war in Ye­men that star­ted in 2015 ad­ded mo­re fuel to the fis­cal fi­re. That sa­me year, the cru­de pri­ce nee­ded to reach the break-even point was no less than $106 per ba­rrel.

In Ju­ne 2015, Ali al Nai­mi told the press in Vien­na: “Our stra­tegy is wor­king. De­mand is pic­king up. Good! Supply is slo­wing, right? I’m not stres­sed, I’m happy.”

On­ce the im­pact on un­con­ven­tio­nal pro­duc­tion was achie­ved, pri­ces re­co­ve­red, with Brent reaching $50 in 2017 and stea­dily gro­wing un­til la­te 2018.

It see­med that the pri­ce war had in­deed wor­ked. Sau­di Ara­bia’s pro­duc­tion was ri­sing, ex­cee­ding 12 mi­llion ba­rrels per day in 2016, on par with pri­ces. But alarms went off on­ce again by the end of 2018.

The U.S. fracking in­dustry, far from being in­ti­mi­da­ted, ca­me back with stri­king fe­ro­city, lo­wer costs, and so­lid in­dus­tria­li­za­tion of the pro­cess. The fact that many of their wells we­re fi­nis­hed and only wai­ting for the star­ting shot to be­gin fracking sti­mu­la­tion and pro­duc­tion al­so con­tri­bu­ted.

No­wa­days, the Uni­ted Sta­tes’ pro­duc­tion is nea­ring 12 mi­llion ba­rrels of oil equi­va­lent, clearly sur­pas­sing Sau­di Ara­bia, and is set to reach 13 mi­llion ba­rrels over the co­ming months. Russia is not far behind, pum­ping 11.3 mi­llion ba­rrels per day in Fe­bruary 2019. This, of cour­se, leads to a new de­cli­ne in oil pri­ces, cu­rrently at just over $60.

In ad­di­tion to this, the Uni­ted Sta­tes has be­co­me a re­le­vant oil ex­por­ter, al­ready ac­coun­ting for 7% of the cru­de supply to Eu­ro­pe.

Meanw­hi­le, Ara­bia won­ders what all this ef­fort has led to. Per­haps be­cau­se of this, just li­ke it hap­pe­ned in 1986 with Sheikh Ya­ma­ni, mi­nis­ter Ali al Nai­mi was re­pla­ced with Kha­lid al-fa­lih in 2016, who an­noun­ced that in March of this year the na­tion will re­du­ce pro­duc­tion to 9.8 mi­llion ba­rrels, going back to the stra­tegy of cur­bing pro­duc­tion, in co­lla­bo­ra­tion with the rest of the OPEC.

This ca­se re­minds us that pri­ce wars ra­rely work. On this oc­ca­sion, not only was a hu­ge tur­no­ver lost but al­so so­me com­pe­ti­tors grew stron­ger af­ter adap­ting their pro­duc­tion costs to a mo­re de­man­ding en­vi­ron­ment. This is the ca­se of U.S. fracking, whe­re pri­ces can reach up to $25 per ba­rrel.

The stra­tegy to re­du­ce pri­ces was not the only fai­lu­re. Sau­di Ara­bia’s di­plo­ma­tic in­ter­ven­tion in the Sy­rian war was al­so a fai­lu­re, not ma­na­ging to de­po­se As­sad or en­ding the war in Ye­men. It seems li­kely that the re­turn of the oil pro­duc­tion dan­ce will be ac­com­pa­nied by the tra­di­tio­nal check­book di­plo­macy that of­fe­red such good re­sults th­roug­hout the years.


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