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A price battle in the oil market

Brent crude, the benchmark oil future, slumped to a four-year low around $80 a barrel this week; US futures fell to a three-year trough of $77. This was due to Saudi Arabia, the key producer in the oil-exporting cartel Opec, reducing the price it charges US customers. It also raised prices slightly for Europe and Asia.

Brent has now fallen by almost 30% since June. Conflict in the Middle East did not, as initially feared, disrupt Iraqi exports. Libyan production has recovered, US shale output has soared, and demand has slowed amid sluggish growth in Europe and Asia.

What the commentators said

Given the oil market backdrop, Saudi Arabia has two options, said Anjli Raval in the FT. It can accept a period of lower prices to retain market share, or cut production and sacrifice its market share in defence of higher oil prices. It seems to have opted for the former.

No wonder, said Nathaniel Kern of consultancy Foreign Reports. Demand is weak in the oil market, so if it were to cut production instead, it might end up having to “cut again and again”, sacrificing more market share than expected.

Bolstering prices would also encourage more shale production in America. Now they “appear to be digging in for a drawn-out price war” there to protect their market presence.

They reckon that US shale oil projects can’t withstand a protracted slump in crude prices owing to their relatively high costs, noted Tim Webb in The Times.

Indeed, $80 is often cited as the threshold needed for a shale project to break even. The Saudi budget needs oil at $85 to break even, but the government has plenty of cash reserves.

The global oil market is “entering one of its periodic games of chicken”, said the FT. The Saudi are convinced US shale production will slump if prices stay around $85 a barrel. But the shale producers “see it differently”.

Executives from several companies say they can raise output; hedging strategies have “locked in higher prices for a year or two”; and there is scope for further cost reductions and productivity improvements.

So, if American shale doesn’t “swerve first”, and Opec also doesn’t cut back, we could face a major glut next year. That would be “a clear net benefit for the world economy” – including for America, which remains a major importer despite the shale boom.

Money Week
Published on:
November 6, 2014
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