The Re-energised US Oil Sector: More Woes for Saudi Arabia and OPEC?

15 March 2017 Lindsay Hughes, Research Analyst, Indian Ocean Research Programme

Background

The oil industry in the United States continues to recover from its most recent setbacks – falling oil prices – that were brought about in part by the Organisation of Petroleum Exporting Countries (OPEC), which, to a large extent, is led by Saudi Arabia. To the Saudi way of thinking, the glut of oil in Europe, coupled with an unseasonably warm winter, saw demand for oil fall, leading to prices hovering around a low of US$25 per barrel. The situation clearly was unsustainable for Saudi Arabia, where oil exports constitute around 90 per cent of revenues. While this situation was clearly untenable for Saudi Arabia, it was, however, catastrophic for many other members of OPEC. The recovering oil industry in the US, therefore, does little to alleviate OPEC’s problems.

Comment

In the wake of the oil price slump, OPEC and non-OPEC countries agreed to impose cuts on oil production to boost prices and, hence, their revenues. On the one hand, this was a major concession for Saudi Arabia, which feared that reduced output could lead to a similarly-reduced market share when prices recovered. For a country that depends upon oil revenues to the extent that Saudi Arabia does, any decrease in market share is a serious concern. Riyadh, however, banked upon its vast foreign exchange holdings to tide it through what it hoped would be a short-lived period of oil gluts and price reductions. It hoped that the oil surpluses in Europe and North America would reduce once weather patterns in those regions returned to normal.

The effect of Saudi Arabia’s refusal to reduce oil output on fellow OPEC countries that did not have the luxury of the former’s wealth, however, was catastrophic. Venezuela’s current problems stem, to a large degree, from this situation. Exacerbating the situation was Riyadh’s distrust and fear of Russia, the world’s largest energy exporter, which is not an OPEC member, and thus difficult for Saudi Arabia to influence. Like Saudi Arabia, Russia depends on energy exports to maintain its growth. While these earnings are supplemented by arms sales, Russia has seen that sector diminish as valued customers such as India, which once purchased their military systems solely from Russia, diversify their sources to include American, European and Israeli weapons and systems. This has only served to increase the importance of Russia’s energy exports.

It was the pressure brought to bear on Saudi Arabia by its fellow OPEC members to reduce oil output that saw Riyadh agree to cap its production. While the price of oil did rise initially to around US$50 a barrel, the US oil industry soon dealt any hopes of a complete comeback a body blow. The US oil industry, which had seen its development of shale oil sites drop off due to deflated prices, soon grew once more as the price of oil rose. Saudi Oil Minister Khalid al-Falih stated that US shale oil producers would need higher prices to compensate for higher production costs. Those hopes were soon dashed, however. The number of active rigs drilling for oil rose for a solid ten continuous weeks before falling slightly in January this year. The Energy Information Administration, consequently, released a report that forecast a rise in shale oil output of about 41 thousand barrels a day to bring total output to close to 4.75 million barrels a day.

The volume of oil being produced aside, the gains in efficiency of production herald additional worries for OPEC and non-OPEC oil producers. This, it is estimated, could lead to output rising by around half-a-million barrels per day by the end of the year, according to one conservative estimate. OPEC projected a rise in the demand for oil in mid-February 2017. The organisation likely hopes that this projection, coupled with its decrease of oil by around 890,000 barrels a day in January, will see prices rise once more. OPEC plans to remove 1.2 million barrels per day in order to force prices upwards. It was Saudi Arabia, however, that made the largest proportion of cuts to production, reducing that by around 496,000 barrels a day.

This could be a trying time for the Saudi authorities. They will be hoping that these measures pay off and oil prices rise once again. Much rests on this gamble. If Iran, which is in the process of resetting its own oil production to pre-sanction times, decides not to comply with the production cuts or if, say, Russia or the other eleven non-OPEC countries arrive at a similar decision, Saudi Arabia could find itself in a lot of trouble.

Riyadh has made a large wager. Time will soon tell if the gamble was successful.

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