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Dwayne Purvis

Dwayne Purvis

Dwayne Purvis, P.E. is a reservoir engineering and management consultant based in Texas.  Find commentary and free resources at www.dpurvisPE.com. Besides writing and speaking on…

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Does Saudi Arabia’s Play For Market Share Make Sense?

Does Saudi Arabia’s Play For Market Share Make Sense?

Props to Saudi Arabia. Unlike other producers, including U.S. shale producers, it maintained financial strength and flexibility during the last boom. When it began to shift the paradigm of global supply, the kingdom was explicit about its goal—market share—even if it didn’t always trumpet the proactive steps it was taking towards that goal. The now-evident objective of low prices, having been achieved and sustained, begs the question of why Saudi Arabia defended its market share.

The position of Saudi Arabia among producers in 2014 resembled the position of Germany in the European Union in prior years. Both had maintained financial strength despite the prodigal habits of other members, and both were called upon to make unique sacrifices to rescue their neighbors. Germany had closer ties to its partners and seemed to see the ultimate benefit of helping. Perhaps because it didn’t have such ties, Saudi seems to have weighed the benefits differently. Indeed, Saudi had no moral obligation or economic need to sacrifice itself in order to redirect wealth to other producers. Related: Who To Back When Oil Rebounds

Their actions suggest that they intended to drive prices toward a basement price—stepping supply up when prices reached the $60s, slowly tuning it down when prices hit the $40s and below, and increasing its capacity for production even as prices fell. The recent address of Saudi Oil Minister Ali Al-Naimi in Houston was straightforward and polite, but it might be crudely paraphrased as, ”Get used to the low prices. Adapt or die.”

The possibility of his bluffing is belied by historical actions. As recently as Monday, the OPEC report on monthly volumes showed the kingdom continuing to produce more than half a million barrels a day above its rates in late 2014. Saudi Arabia has had the will and means to drive prices, giving market forces some push.

As oil has been its only resource and industry of value, the kingdom has treated the business as the treasure that it is. The centuries-long fate of the royal family and its kingdom depends upon how they manage themselves during the era of oil, particularly the epoch of increasing demand. Surely, the highly intelligent, disciplined and motivated planners knew the short-term consequences of the actions which the rest of the world is just beginning to appreciate fully. And even last month, Minister Al-Naimi professed the acceptability of $20 oil. Related: U.S. Lifted The Crude Oil Export Ban, And Exports Went…Down

Normally the benefit of market share is obvious—increased revenue and increased performance. This assumes, however, stable prices and economies of scale. If one maintains market share, or even gains a few percent, but prices drop by 50 or 70 percent, then revenue drops to half or a third of what it had been. Said differently, the Saudis could have absorbed all of the increasing production from the rest of the world, dropped their production by half to about 5 million barrels per day (mb/d) and still have had the same or more revenue than they have enjoyed during this transition. Market share is not its own reward. Evidently Saudi Arabia has some strategic plan that results in its making more money in the long run than it is losing in the short run.

Perhaps the Saudis view ‘market share’ not just in terms of oil production but in terms of total energy use. By 2014 shale oil had posted an acute rise in supply, and other high-cost sources like oil sands were building momentum. Natural gas and renewables were tracking their own, chronic ascent. Moreover, the high cost of oil created incentives toward alternatives, both unconventional oil and non-oil forms, and global demand growth for liquid oil was forecast to grow below historical trends due to conservation and lesser economic activity. Minister Al-Naimi has said that oil demand would peak long before supply. Before the current price crash, that peak demand was within sight, perhaps 2040 give or take a decade. High prices were slowly killing the goose that lays the golden eggs.

If the strategic focus on market share does not involve increased revenue or efficiencies, then the market power is the only compelling explanation for the strategy. With power they can perhaps maximize their own decades-long revenue stream rather than passively treat their national treasure as a cash cow, perhaps exerting some control over their own destiny rather than ceding to less economically rational sources. Related: Oil Prices Beyond WTI And Brent

The new paradigm of supply/demand balance seems to have at least two major tenants: Price should be low enough to discourage run-away supply and perhaps to encourage the use of oil. Saudi Arabia may cooperate but will not unilaterally support prices. Around these pillars are two routes back to prices which can sustain long-term supply: slow rebalancing as supply slides and demand creeps, with cooperation for widespread cuts. Or prices could recover by a challenge to the new paradigm, namely conflict to threaten or to interrupt even a small portion of supply.

A freeze in production growth as headlined in the last month would be a mostly irrelevant step on the first route or a minor step towards the second route. The large majority of OPEC production comes from countries not able or not inclined to increase production. With Iran still adamantly and publicly opposed, the idea of a freeze in supply growth is more publicity than policy change. Perhaps the most important take-away is that Saudi Arabia has signaled that its floor price is somewhere above $30.

Even if cooperation cannot be achieved, the rest of the world may not remain a hapless victim of Arabian pricing power. Oil consumers may appreciate the drop, but countries like Russia and Iran do not. They also have motives and objectives similar to those of Saudi Arabia; they desperately need oil revenue. Only they have different forms of power at their disposal to influence oil price.

By Dwayne Purvis for Oilprice.com

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  • Bill Simpson on March 28 2016 said:
    If I was a Saudi ruler, the strategic plan I would have would be to get rid of as much of the competition as I could. They can't get rid of all of it, because they can't get rid of Russia, Iran, Iraq, or Venezuela. Luckily for the Saudis, that national competition, which they can't eliminate, can't supply world oil demand on their own. The world needs more oil than they can produce by themselves. A good part of that additional oil is currently produced with the help of large private oil companies - the super majors. They are the prime Saudi target.
    Reduce the size of the largest private oil companies, and their oil production will eventually fall. That fall will drive the price of oil way up in the future. The Saudis will more than make up for the lost revenue today, by the huge coming price spike as existing oil fields operated by the super majors are depleted, and not replaced by additional fields which aren't being discovered today, as low prices force cutbacks in oil exploration around the globe.
    It is a risky strategy because it could cause a massive spike in the price of oil within 5 years. Such a spike, or actual shortage of oil, could cause an economic crisis which could bring down the entire financial system, which is overburdened by a record level of debt. With such debt, the financial system is highly unstable. Look at what happened in 2008. And since then, debt has substantially increased.
    Even if prices didn't spike, a shortage of oil would force the global economy to contract. Less oil produced means less work is accomplished. It is physics. The result would be the same - the danger of a collapse. That is a black swan few today expect, but could easily materialize before any replacement for oil could begin to displace it.
  • John Scior on March 29 2016 said:
    Perhaps part of the "market share" that the Saudi's were defending was the one where at the higher price of oil, alternatives were being developed that threaten the core of their wealth such as electric vehicles ad alternative fuels that could be used as an alternative to oil dependence. With oil in the lower price position it is now, less demand is being seen as well as less investment makes sense for ethanol, or biofuel vehicles.
  • Jon on March 29 2016 said:
    Bill said, in part: "The Saudis will more than make up for the lost revenue today, by the huge coming price spike as existing oil fields operated by the super majors are depleted, and not replaced by additional fields which aren't being discovered today, as low prices force cutbacks in oil exploration around the globe. "

    R&D going forward may be curtailed, but the 'frack log' that exists right now, known fields and quantities, those are sitting there, waiting for better economic times...and all the while, the R&D that is being done is looking at improving efficiency to get at previously less than economically viable product.

    There will be some private companies that cannot make it...but those companies, assets, leases and fields will be consolidated, bought up by the companies who can survive this. Thus the lower for longer cycle, as any upturn in crude to the higher $40's and $50's will encourage another round of US production kicking in, in the fields where the product is known to exist and can be accessed relatively quickly and easily...and there is a lot of that.
  • CrazyBoy on March 29 2016 said:
    It could prove risky to invest in any new production even from known fracking fields. At this point, the Saudis control the price of oil. If they notice $48 is encouraging new production they will simply drop the price.
  • MoreFreedom on March 31 2016 said:
    One could make the case that Sunni Saudi Arabia is trying to destabilize Iran which is a Shia Muslim nation by reducing their oil income. It also affects the revenues of Assad of Syria, who's fighting against a Sunni ISIS. Saudi Arabia also has a minority of Shia Muslims, who are a thorn in the side of the House of Saud. And the House of Saud spends a lot of money promoting their version of Sunni Islam.

    The Sunnis and Shias have been fighting each other for centuries. They haven't learned that to have the prosperity that comes with freedom, they must first be willing to give freedom to others before they have will freedom. And their religious leaders teach them they should rule over all others.

    This may not be the main factor, but it seems like a significant one.
  • John on April 17 2016 said:
    The sole reason for deliberate oil glut is to hurt Russia and Iran.
    The market share is a bull

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