Sometimes it’s funny listening to armchair quarterbacks, the ones who comfortably critique the pros because there is zero chance they’ll ever be in a position to show the world how miserably they’d perform in a similar situation. It’s not just a sports phenomenon; we see it in business too.
A recent wave has been OPEC bashers, specifically Saudi Arabia. While some of us (ahem) may make fun of their gold Ferraris, it is very unwise to think they don’t know what they’re doing when it comes to oil markets.
Tectonic shifts are happening in the energy world. Your morning tour through the news will bring endless waves of stories about endless shale resources and cities abandoning fossil fuels, but that’s noise. It’s not real news nor is it what’s important. Saudi Arabia is at the epicenter of what we should be watching as the world’s petroleum juggernaut reinvents itself. In addition to the most-welcome developments with respect to women’s rights, religious moderation, and the crackdown on corruption, the aspect that will get everyone’s attention will be higher gasoline prices flowing from the near-inevitable oil price spike that is coming.
There is ample evidence to suggest that a Saudi rebranding master plan is underway, and key to this is the privatization of Saudi Aramco. Recall that until a decade ago, Saudi Aramco was the beginning, middle, and end of the Saudi economy. It was the tool by which OPEC kept global oil prices where they wanted them; its aura of mystery and omnipotence gave it the ability to control the price of the world’s most valuable energy input however they wanted.
But the Saudi world is changing at the speed of a golden Ferrari. In fact, if the young new ruler has his way all those gold monstrosities will be swept up and sent to auction as his corruption crackdown continues. Perhaps the soon-to-be-destitute (if not imprisoned) young jet setters will be settling for bronzed Kias.
The Saudi world is also changing with respect to oil, and this is an aspect that may have been missed by those who think OPEC is clueless. The consensus view is that shale oil is all that matters in the world of oil production, and that if prices bounce back above $60 the world will be flooded with shale oil. It’s not true. Texas might be flooded with shale oil, but even optimistic shale output gains of 1 or 2 million barrels per day would only satisfy global demand growth. Keep in mind that even if shale output grew that much it wouldn’t flood the market – just help balance it. And global declines are roughly 2-5 million b/d per year.
Saudi Arabia of course knows that, and from the tealeaves it looks like they have been playing a longer game. Only the Saudis know the true productive capability of all their assets, though some good guesses have been made by the likes of the late Matthew Simmons in Twilight in the Desert (which may have been a bad guess, but it sounded pretty plausible). Saudi Arabia did make some decisive moves such as in late 2014 when they cratered oil prices by refusing to cut output in response to rising oil output. The consensus view was that it was a direct response only to growing shale production, but the fact was that with sustained $100/barrel oil prices oil was flowing forth from the remotest geographical orificies, including the massive Canadian oil sands.
The about-face on oil pricing may well have been part of a plan put in motion a few years earlier. Consider this:
In 2011, Saudi Arabia had little more than 20 rigs drilling for oil. That number ramped up steadily to about 70 by late 2014 when they decided to let the price free fall. Note that from 1995 to about 2004, Saudi Arabia grew production unevenly but decisively with fewer than 20 rigs working, although this performance was helped by a number of new field megaprojects. From 2012 to 2017 the same growth trajectory required from 40 to 80 rigs working continuously.
What this all means is that Saudi had a multi-year plan to ramp up production to all time highs as part of the plan to shake out high cost producers, and then engineer something else. One clue to this is the declining oil rig count from early 2015 until now. But that is a weak clue; there is a much stronger one that indicates they are not acting randomly.
In addition to all the societal changes –the women drivers, the $500 billion planned megacity, and the incoming prison inmates garbed in Gucci – SA is planning an IPO of Saudi Aramco. The valuation of the company is a complete wildcard – estimates range from less than one to $2 trillion, and only time will tell what that is. But what we do know is that this is the sale of the crown jewel, the bedrock of the Saudi economy for more than 50 years. As such, it is unfathomable to presume that the Saudis will allow a low-ish oil price when that happens.
OPEC is powerless, you think? Shale oil will flood the market? It can overwhelm US demand, but not global, and even to do that would take years and much higher prices. Saudi Arabia could take 2 million barrels per day off the market tomorrow. Any replacement barrels would face huge lead times – imagine capital spending ramping up in the oil sands again. It would take 6 months of sustained prices before deer-in-the-headlight executives would consider talking about possibly allocating the billions necessary, which would not show up in pipelines until some years after that. Even shale output would be hard pressed to react quickly; any sudden ramp up in activity will show how bare the oilfield services cupboards are.
Since this is a once in a lifetime liquidation for Saudi Arabia, it is inconceivable that their clever tacticians won’t pull out all the stops to send oil prices skyrocketing. To not do so would be to reduce the value of their prized assets by hundreds of billions. Enjoy the ride, we may get one more oil boom to take for granted yet.