NEW YORK (MarketWatch) — With oil prices tumbling — and dragging gasoline prices at U.S. pumps further below $4 a gallon — investors wonder if Saudi Arabia will cut production in an effort to stop the slide.
Don’t count on it.
In a note, commodity strategists led by Seth Kleinman at Citi argue that the Saudis aren’t likely to throttle back output, in part because they apparently “think that they can win any price war” with U.S. shale producers.
In other words, Saudi producers are playing a long game, confident that “full cycle” shale production costs are considerably more than their own.
As Julian Jessop, head of commodities at Capital Economics points out, there is precedent. Saudi Arabia responded to a glut of non-OPEC oil in the latter half of the 1980s by increasing its own output, successfully eroding the profitability of other producers, including those in the North Sea, he said.
Oil futures remained under pressure Wednesday, with the price of light, sweet crude for November delivery CLX4, -1.43% on the New York Mercantile Exchange falling $1.54, or 1.7%, to $87.31 a barrel, hitting the lowest price for a most-active contract since April 2013 after data showed a further rise in U.S. crude supplies. ICE November Brent crude futures LCOX4, -0.61% fell 58 cents, or 0.6%, to $91.53 a barrel, setting a two-year low.
Saudi Arabia earlier this month cut the official selling price for its crude, according to news reports, a move that put additional pressure on oil prices at the time.
The Citi analysts say the Saudis might be right to think they can win a price war, but only up to a point.
Comments by Saudi officials indicate they continue to believe shale oil requires a price of $90 a barrel to be profitable, the analysts noted. While the Saudis think this represents a new floor for oil prices, the floor is actually falling as shale-oil production technology continues to improve, Citi said. (It costs just a few dollars a barrel to extract Saudi Arabian oil, but the International Monetary Fund in September estimated that the “breakeven” price required to balance the country’s budget rose to $89 a barrel in 2013 from $78 in 2012.)
Moreover, this supposed floor reflects the “full cycle costs” of production, they said, arguing that this overlooks the fact that many producers in North Dakota, Texas and elsewhere have already acquired acreage, contracted rigs and even hedged crude prices.
“We think what counts at this stage is half-cycle costs, which are in the significantly lower band of $37 to $45 a barrel. This means that the floor is falling and may not be nearly as firm as the Saudi view assumes,” they wrote.
“Even at $75 a barrel or perhaps below, U.S. oil production would almost certainly grow in 2015 an 2016, not changing much the need for OPEC to cut if the market is to be balanced. Even if such a price war were ensuing, the Saudis would end up punishing themselves in our view. They could sustain the pain of $60 a barrel oil for a while, but definitely not forever.”
The bottom line, they said, is that the Saudis could conceivably win a price war, but it would be a “painful, pyrrhic and short-lived” victory as the price floor for shale continues to fall.