Saudi Arabia’s Oil-Price War Is With Stupid Money

(By Art Berman)

Saudi Arabia is not trying to crush U.S. shale plays. Its oil-price war is with the investment banks and the stupid money they directed to fund the plays. It is also with the zero-interest rate economic conditions that made this possible.

Saudi Arabia intends to keep oil prices low for as long as possible. Its oil production increased to 10.3 million barrels per day in March 2015. That is 700,000 barrels per day more than in December 2014 and the highest level since the Joint Organizations Data Initiative began compiling production data in 2002 (Figure 1 below). And Saudi Arabia’s rig count has never been higher.

Berman Saudi #1

Figure 1. Saudi Arabian crude oil production and Brent crude oil price in 2015 U.S. dollars. Source: U.S. Bureau of Labor Statistics, EIA and Labyrinth Consulting Services, Inc

Market share is an important part of the motive but Saudi Minister of Petroleum and Mineral Resources Ali al-Naimi recently emphasized that “The challenge is to restore the supply-demand balance and reach price stability.” Saudi Arabia’s need for market share and long-term demand is best met with a growing global economy and lower oil prices.

That means ending the over-production from tight oil and other expensive plays (oil sands and ultra-deep water) and reviving global demand by keeping oil prices low for some extended period of time. Demand has been weak since the run-up in debt and oil prices that culminated in the Financial Collapse of 2008 (Figure 2 below).

Berman Saudi #2

Figure 2. World liquids demand (consumption) as a percent of supply (production) and WTI crude oil price adjusted using the consumer price index (CPI) to real February 2015 U.S. dollars, 2003-2015. Source: EIA, U.S. Bureau of Labor Statistics, and Labyrinth Consulting Services, Inc.

Since 2008, the U.S. Federal Reserve Board and the central banks of other countries have further increased debt, devalued their currencies and kept interest rates at the lowest sustained levels ever (Figure 3 below). These measures have not resulted in economic recovery and have helped produce the highest sustained oil prices in history. They also led to investments that are not particularly productive but promise higher yields that can be found otherwise in a zero-interest rate world.

Berman Saudi #3

Figure 3. U.S. Federal Funds rates and WTI oil prices in January 2015 U.S. dollars. Source: U.S. Bureau of Labor Statistics, EIA and Labyrinth Consulting Services, Inc.

The quest for yield led investment banks to direct capital to U.S. E&P companies to fund tight oil plays. Capital flowed in unprecedented volumes with no performance expectation other than payment of the coupon attached to that investment.

This is stupid money. These capital providers are indifferent to the fundamentals of the companies they invest in or in the profitability of the plays. All that matters is yield.

The financial performance of most companies involved in tight oil plays has been characterized by chronic negative cash flow and ever-increasing debt. The following table summarizes year-end 2014 financial data for representative tight oil-weighted E&P companies.

Berman Saudi #4

Table 1. Summary of 2014-year end financial data for tight oil-weighted U.S. E&P companies. Money values in millions of U.S. dollars. FCF=free cash flow (cash from operations plus capital expenditures); CF=cash flow; CE=capital expenditures. Source: Google Finance and Labyrinth Consulting Services, Inc.

Some rationalize the negative free cash flow as an expansion of capital base that will result in future profits. The following table shows that over the past 4 years, tight oil negative cash flow increased and has reached a cumulative of more than -$21 billion for the representative companies. Almost half of that negative cash flow took place in 2014.

Berman Saudi #5

Table 2. Summary table of cash from operations and capital expenditures for tight oil-weighted U.S. E&P companies. Values in millions of U.S. dollars. Source: Google Finance and Labyrinth Consulting Services, Inc.

The average U.S. oil price from January 2011 through year-end 2014 was $95 per barrel. First quarter 2015 performance at $48.50 WTI will be a disaster that makes the previous 4 years look good.

How long do the losses continue before the cheerleaders of shale plays admit that the enterprise is not profitable? Only the more diversified integrated companies like ConocoPhillips, Marathon, and OXY show meaningful long-term positive cash flow. If companies could not show positive cash flow at $95 per barrel, what price is necessary and what will that do to the world economy?

Some of my readers dispute the poor economics of these plays based on incorrect notions of break-even profitability–some believe that tight oil plays are profitable at $35 per barrel oil prices (see comments from my last post).

Following are two slides taken from Schlumberger CEO Paal Kibsgaard’s recent presentation at the Scotia Howard Weil 2015 Energy Conference held in New Orleans. These slides present a well-informed and objective view of how tight oil plays compare to other plays.

In my Figure 4, Mr. Kibsgaard shows that the average break-even price for tight oil plays is about $75 per barrel. By comparison, Middle East OPEC break-even prices are less than $10 per barrel. Other conventional oil plays break even at less than $20 per barrel.

Berman Saudi #6

Figure 4. Slide from Schlumberger CEO Paal Kibsgaard’s presentation at the Scotia Howard Weil 2015 Energy Conference.

In my Figure 5, Mr. Kibsgaard shows Schlumberger’s assessment of drilling intensity or efficiency. For nearly equal oil-production volumes of about 11 million barrels per day, U.S. oil producers drilled more than 35,000 wells and 297 million feet of hole compared to 399 wells and 3 million feet of hole for Saudi Arabia.

Berman Saudi #7

Figure 5. Slide from Schlumberger CEO Paal Kibsgaard’s presentation at the Scotia Howard Weil 2015 Energy Conference.

U.S. companies drilled almost 100 times more wells to reach the same daily production as Saudi Aramco. Strident claims of increased efficiency by tight oil producers sound absurd in this context.

Prolonged low oil prices will prove that tight oil plays need at least $75 per barrel to break even. When oil prices recover to that level, only the best parts of the tight oil core areas will be competitive in the global market. As production declines from expensive tight oil, oil sand and ultra deep-water plays, inexpensive Saudi oil will gain market share.

Saudi Arabia is not trying to crush tight oil plays, just the stupid money that funded the over-production of tight oil. Too much supply combined with weak demand created the present oil-price collapse. Saudi Arabia hopes to prolong low prices to benefit their long-term needs for market share and higher demand.

—————

This article was written by Art Berman and can be found at his website, ArtBerman.com.

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28 Comments on "Saudi Arabia’s Oil-Price War Is With Stupid Money"

  1. silverfreaky | April 22, 2015 at 9:37 am |

    The next support level is 14,15$.

  2. All this flushing black gold in comparison with the peak cheap oil before 2020 meme gives me a headache. What’s the expected decline in production in the coming 5 years, 4% per annum? That’s about 25%, and that should be more than enough to push the world economy over the cliff. But it’s a tough one to believe with all this oil drowning storage capacity.

    Ehmmm, i think i need one more confirmation on this Steve. Ron Patterson said peak is now. When oil production is 25% less in 2020 than it is now, the crash must be so big the Saudi’s won’t sell one drop because the whole fiat system blows up.

    • houtskool,

      The average decline rate of a new shale oil well is 40-50%. By the fourth year its 90+% depleted. If the price of oil remains low, and it looks as if the Saudis will do their best to keep it there, then we are going to see a great deal of U.S. shale oil production to decline by 2020.

      steve

  3. Many ultra-deep water drilling in the Gulf of Mexico is profitable today at 40 a barrel. And these wells produce for decades in many cases once drilled.That is why Ultra-Deep water will save the day when the Shale goes down.

    • Howie,

      While Deep Water is more profitable than Shale, the typical Deep Water well also suffers extremely high decline rates. Do you remember the GRAND THUNDERHORSE FIELD? It’s production peaked only after a few years. Furthermore, even though production at the Thunderhorse Field has ramped up a bit lately, it most certainly was a disappointment for the industry.

      Do not believe for one minute that DEEP WATER will make up for the coming decline in Shale Oil. We must remember, Shale Oil production accounts for 5.5 million barrels a day of the 9.2 Mbd of current production. Deep Water is a very small percentage.

      steve

  4. David Smith | April 22, 2015 at 6:34 pm |

    Steve,

    How extensive is hedging by the tight-oil crowd? I have read stats that claim – due to hedging – that the industry can “ride out” this decline for another year or so before they have to face the music of this new lower price oil environment. I would think that, at the very least, the marginal players have been unable – not prescient enough – to have hedged their production early on into the initial decline from sub $100/bbl oil.

    • David,

      I am not sure of the degree of HEDGING in the industry, but according to Art Berman’s data in the article, the top Shale Oil companies stated a negative $10 billion in Free Cash Flow in 2014. If this was including hedging, they are in a world of hurt when those hedges do run out.

      I truly believe we are going to see serious trouble and bankruptcies in the Shale Oil & Gas Industry by the second half of the year.

      steve

  5. Hi Steve,

    Do you have any idea how much potential toxic junk bonds they sold into the pension system I’ve heard north of 1 trillion? The reason I ask is bc at dinner tonight I was with a group of retired teachers and they were all talking about how much their pensions have gone up in the last couple yrs.. I know that a lot of those gains were energy junk bonds bc with it difficult to find yield they’re moving Into riskier assets

    • Adam,

      That figure is really just speculation. However, I listened to a recent interview with Chris Martenson at Peak Prosperity with John Michael Greer on this subject who stated that the figure he found was twice what was used to prop up the Sub-Prime Housing Market back in the 2000-2007 period.

      The U.S. Shale Oil & Gas Industry need much higher energy prices to survive. That being said, the typical peak of a shale oil or gas play is about 7 years. The Bakken & Eagle Ford stated about 2008. So, if you add 7 years to 2008, we should be seeing a peak in these two fields shortly.

      steve

  6. Conservation is a word that passes no lips.The fools are in charge of the schools,the insane of the asylum.Greer sees far enough ahead,as does Martenson,to an extent. So now what? They ramp up production for political and economic warfare,and the planet suffers even more. The new low prices mean we could all drive to Florida just for the hell of it.And Deep Water?Have you forgotten the biggest ever spill and millions of lives destroyed by that? Who cares? It’s all bloody money.Or tOO late.

  7. Hi Steve,

    Do you think that the significant increase in Saudi Arabian oil and gas rigs from 100 in 2011 to a record high in 2014 of 210, confirmation that the Ghawar, Safaniya, Abqaiq and Berri super giant oilfields are now most likely in decline?

    • Michael,

      That’s a good question. I do believe the Saudi’s are doing a lot of EOR- Enhanced Oil Recovery techniques to offset their annual decline rate. We must remember, the Saudi’s are pumping in something like 6 million barrels a day of sea water to get the oil in some of their largest fields.

      This extra drilling and additional wells may have provided them with more oil in the short-term, but I imagine they are increasing the overall depletion of their field quicker. So, in that regard, when the decline of their oil fields finally arrives, it may be quite spectacular.

      steve

  8. silverfreaky | April 23, 2015 at 8:01 am |

    Since silver price is falling like a stone we hear nothing from SRSrocco how much silver is available.
    From the well known silver pages the market is drying out since years.

    • silverfreaky,

      You would be quite surprised how little silver there is compared to what we had in stocks two decades ago. Furthermore, most of the above ground available silver is in the ETFS. How much is really there, is anyone’s guess.

      People need to stop thinking about the current SUPPLY-DEMAND pricing mechanism for valuing silver and focus on PEAK OIL and its negative impact on the valuation of the $100’s trillions of supposed paper assets. This is what gold and silver are competing with… NOT SILLY PRESENT SUPPLY & DEMAND FORCES.

      steve

  9. As of this morning, Porter Stansberry is predicting a global financial collapse in the next couple of months. For those that don’t Stanberry’s work, he correctly predicted that last two crashs and states that this one will be far, far worse.

    Silver is going to hit it’s final low in the next few of weeks, so it is truly the time to back up the truck if you want to be in on the ground floor. By Steve’s calculation about $4.00/oz less than the real cost of production.

    Buy for cash and stash.

    SteveW

    • I have heard of Porter Stansberry; I’ve read a few articles he has written. If he called the last two collapses he was one of several on record of having done so.And many are saying the next one could be much worse.

      However it is tricky business to put a year on such; the most knowledgeable analysts mostly stay away from doing that, let alone a season.

      If I had tons of fiat to divest myself of I would do so into a number of things.

  10. OutLookingIn | April 23, 2015 at 10:10 am |

    There is some new thought out there, that the recent crash of not only the oil price, but of that of coal also, is price discovery that is more reality based. If this be the case, then those dollar assets priced by the ‘pumped up’ so-called recovery printing, must fall also. This is deflationary.

    Adding fuel to the economic recovery that refuses to burn, the Canadian list of oil projects positioned above the cost curve and are uneconomical, continues to grow. The top ten are;
    1/ Frontier
    2/ Joslyn
    3/ Northern Lights
    4/ Gregoire
    5/ Hanging Stone
    6/ MacKay River
    7/ Fort Hills
    8/ Thornbury
    9/ Clyden
    0/ Saleski
    With two more large oil plays on the east coast at Bay du Nord and the Hebron formation.
    If indeed the new reality based price discovery for oil is true, then the warnings of a disaterous EROI is inescapable. This is also deflationary, as oil in the ground assets must fall in value to make them economically viable. Everything is relative.

  11. Steve, thanks a lot for this aricle from Art Berman and your insightful comments. Somewhen Peak oilers will be proven to be right (I definitely don’t look forward to it) – but I wonder when it will be.

    Late Matt Simmon’s book Twilight in the Desert was published ten years ago and here we are with SA producing at full speed 10,3 mn. barrels a day.

    What’s going on ? Do they have way more accessible/producible reserves than is known ? Or maybe injection of water/gas DOES boost the recovery factor in a big way !? Or is it abiotic oil 😉

    Something with the conventional PO theory must be seriously wrong. Andreas

    • Andreas,

      According to some very good sources, Saudi Arabia and many Middle Eastern countries Oil Reserves are probably overstated by a factor of three. This took place in the 1980’s when the Middle East countries artificially boosted oil reserves for higher export quotas.

      The Saudi’s are pumping in 6 million barrels of sea water a day into their oil fields to get the oil. I would imagine they are doing all they can to keep production elevated. At some point, production will collapse.

      steve

  12. Hi Steve-

    Im relatively new to the Peak Oil/Resources story, but have been devouring a lot of the material on both your site as well as Martenson’s PeakProsperity. I’m def still in the “novice” category, but just read Jerome Corsi’s ‘Great Oil Conspiracy’ and have looked into Lyndsay Williams’ ‘Energy Non-Crisis’ thesis.

    I was wondering what your thoughts were on these two individually or on their thesis as a whole?

    Thx for the outstanding work!

    Best,
    Steve

    • Steve,

      I like Lindsey Williams, but believe he is misinformed and mistaken on peak oil. As it pertains to his favorite subject on the Gull Island oil field off Alaska, there’s a lot more HYPE than FACTS. I write about this in detail here: http://www.silverdoctors.com/are-the-elite-misleading-the-public-through-folks-like-alex-jones-lindsey-williams/

      As for Jerome Corsi, I imagine his a OKAY FELLA, but he is just another misguided individual. While he continues to push the ABIOTIC OIL THEORY stating that the Russians drilled a bunch of super deep wells and found all this abiotic oil makes NO SENSE AT ALL when you look at the last chart at the bottom of this article.

      Even though the United States drilled 35,699 wells in 2014 to produce their petroleum liquids, the Russians drilled 8,688. That’s a lot of wells. Why on earth would the Russians be drilling so many damn wells if they had all that ABIOTIC OIL???????????????

      I gather you saw all those question marks. To be Blunt, I believe Corsi is either a DISINFORMATION AGENT or a complete Fool. And I am beginning to question why George Norry (Coast-to-Coast AM) and Alex Jones have him as a guest all the time.

      Steve do you realize Alex Jones and Georgy Norry never mention PEAK OIL or CLIMATE CHANGE?? I am beginning to wonder if the rumors are true that the are bought and paid for by the Elite to keep the masses from understanding the ramifications of peak oil and climate change.

      steve

      • The abiotic oil theory has some other shortcomings, which I never read anywhere:

        We pull all the fossil fuels from deep in the ground. Basically they are Carbohydrates with differing amount of Carbon (C) and Hydrogen (H2). To release the stored Energy in the Carbohydrates we burn them. This is an oxidative process with oxygen (O2) resulting in CO2 and H2O. Now the carbon which was deep under the surface as carbohydrate is in the atmosphere as CO2. How on earth is this carbon supposed to get deep into the ground again, while getting rid of the oxygen (which requires the input of energy), fast enough to form the required amount of Carbohydrates, eg. Oil?

        If oil would be formed abiotically then the CO2 content of the atmosphere would constantly rise until we suffucate to death, while it is unclear where the carbon is supposed to come from.

        Besides, the abiotic rate of formation of carbohydrates would still have a limit just as the biotic one. Maybe higher than the biotic one, but not indefinite. Exponential growth of consumption will not work with the abiotic theory either.

        Scientists assume, that the atmosphere of the earth in the beginning was mostly CO2 and almost no O2 (neglecting Nitrogen and the other elements which did not change much), while today it is the other way around. Photosynthesis used solar energy, carbondioxide and water to produce carbohydrates (structural elements of plants) and Oxygen. Plants grow by photosynthesis, which forms sold matter (carbohydrates) out of water, air (CO2) and (solar) energy.

        In the beginning of earth, CO2 was plentiful. But continued photosynthesis without any matching consumption made it more and more scarce. This forced probably several evolutionary steps to adapt photosynthesis to new low concentrations of CO2. This must have put severe evolutionary pressure on plants. Breathing animals which consume carbohydrates and oxygen to produce CO2 and H2O solved the problem partially for the plants. But still there were alot of carbohydrates from millions of years of phytosynthesis deep under ground. Now humans evolved, who are digging these carbohydrates up and burn it to gain energy, effectively raising the CO2 concentration in the air, which is so vital for plants.

        Humans might not survice all this in the long run, but plants sure will be thankful. They could have devised not better tool to enhance their vital CO2 in the air, which was running low 😉

        But if humans are clever and find their place in these complex natural interactions, without exhibiting -cancer like- exponential growth, it could become a classic win-win situation.

        Concluding: If the abiotic oil theory was right, it would not solve any of the problems. It would at best postpone the problems a bit to the future. But all evidence points to the facts that we have the problems now. Who would go after expensive shale oil if there was readily availabe abiotic oil?

  13. silverfreaky | April 24, 2015 at 6:51 am |

    The deflation scenario comes more and more realistic.
    What this means you can see all day in the silver price.

    So stupid it sounds “Cash is king in the moment”.

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