Sunday, October 26, 2014

The Saudis have the staying power to undercut the competition

According to Deutsche Bank, the Saudi government can sustain itself for almost 8 years with Brent crude at $83/bbl. The nation's government has accumulated sufficient "rainy day funds" to withstand a prolonged period of budget deficits driven by low oil prices.

Source: DB

Armed with such staying power, Saudi Arabia is undercutting the competition in order to expand market share. They know they have the funds to outlast most of the competitors. The goal is to pressure OPEC cheaters as well as to shake out US "tight oil" producers. The Saudis could presumably deal with the notion of US "energy independence", but having Americans export large amounts of crude (currently being debated in the US) and compete head on with OPEC is not acceptable. While Saudi Arabia cannot entirely stop the growth of North American production, it is going to try slowing it.

The Saudis launched their attack with the comment that the nation "will accept oil prices below $90 per barrel, and perhaps down to $80, for as long as a year or two". With energy markets already soft, the selloff acceleration ensued.

Another recent development shows that the Saudis are also willing to back their statement with action. With OPEC already producing 700-900K bbl/d above its quota, Saudi Aramco started undercutting the competition by lowering prices.
Deutsche Bank: - ... we can observe that the differential of Saudi Arabia’s Arab Light blend versus the Oman/Dubai average for Asian deliveries has fallen sharply from a premium of USD1.65/bbl for September loadings to a discount of USD1.05/bbl for November loadings. This suggests that Saudi Aramco is determined to maintain current levels of exports at the expense of sales prices achieved. This represents the sharpest discount since the -USD1.25/bbl level observed in December 2008, during a quarter in which global oil demand contracted by 3.0 mmb/d, in contrast to the current quarter when we still expect oil demand to grow by 0.8 mmb/d.
Source: DB

The November OPEC meeting is expected to be tense, with a number of nations pushing for production cuts. But ultimately the Saudis will prevail and the pressure on high-cost crude producers will continue. Pain will be felt in Iran, Russia, Venezuela, as well as across the North America's energy sector.

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