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Saudi Arabia biting More than what it can chew

Unlike Russia and Saudi Arabia, the crude oil production from USA is largely from the shale gas wells.

by N.S.Venkataraman

During the last few decades, the global price of crude oil has been fluctuating from record low level to record high level. No speculator or intelligence agencies or research organisations in the world have been able to predict the price behavior of crude oil with any reasonable level of accuracy in the last few decades . The present price of crude oil hovering around US$ 23 to 29 per barrel has not been speculated by any agency in the world six months back.

While it is a fact that the occurrence of coronavirus and it’s rapid spread across the regions in the world and consequent slide down in the global stock market is unpredictable , even these uncertain conditions do not justify the present price of US$ 23 to 29 per barrel, considering the production cost of crude oil and other related factors such as maintenance and falling yield due to ageing of the wells etc. and the need for new oil exploration efforts to sustain the production.

China is the second largest consumer of crude oil in the world after USA and major portion of China’s requirements are met by import from several countries. When the coronavirus onslaught happened in China leading to closure of several production centres and consequent fall in the demand for crude oil from China, the oil producing regions were thrown into a quandary. Then, Saudi Arabia suggested to other oil producing countries, particularly Russia, to balance the crude oil production with the demand and when Russia refused to accept this proposal of Saudi Arabia ,the crude oil price war started.

Though it is reported that it is a price war between Russia and Saudi Arabia, it appears that the big victim of the price war will also be USA. At present, USA is the largest producer of crude oil in the world due to shale oil bonanza, with USA producing around 13.2% of the world production followed by Russia with 12.7% and Saudi Arabia with 12.5% , in the total global crude oil production of around 80 million barrels per day.

Unlike Russia and Saudi Arabia, the crude oil production from USA is largely from the shale gas wells.

There are practical difficulties in extracting the shale oil due to environmental factors and other reasons. Unlike traditional oil, shale oil is more capital-intensive for extraction. This is because the shale oil is found trapped in rocks and to extract it, the producer must drill horizontally. In traditional oil wells, the oil (like water) finds its own level, so it needs only one vertical

drill to exploit the reserves. To extract shale oil, several horizontal drills are required. About 70+ per cent of shale is recovered from the well in the first year, and thereafter, the recovery tapers (long tail).

If the global price of crude oil at US$23 to 29 per barrel would persist, the shale wells in USA can not sustain themselves economically and would be forced to close down. USA is the largest consumer of crude oil in the world to the level of 20 million barrels per day and domestic consumers in USA would choose to import crude oil from abroad rather than buying the more expensive shale oil produced in USA.

It remains to be seen how the US government would tackle the situation. If the global crude oil price would remain at US$ 23 to 29 per barrel when shale well operations in USA would become uneconomical, will the USA government protect the interests of the US shale oil producers by subsidizing the shale oil production cost. To what extent US government can do this and how long it can do this is a matter of conjecture.

In any case, the net result of the Saudi Arabia - Russia price war would be that the crude oil production in USA would suffer heavily , as it’s price would not be competitive with the global market price.

Perhaps, this is the reason why Russia is unwilling to reduce the crude oil production inspite of fall in global demand , as it wants to settle scores with USA by forcing fall in crude oil production in USA.

Probably, the plan of Russia is that if the global share of USA in the crude oil production could be significantly brought down from the present level of 13.2% and the collapse of the Saudi Arabian economy could be forced due to low crude oil price, then Russia will become the dominant producer of crude oil in the world and then can dictate terms. This calculation of Russia seems to be logical from Russia’s point of view.

Further, with the ongoing trade war between USA and China and Russian and Chinese governments having friendly relations, will China start buying crude oil from Russia in a big way and if Russia can ensure this, then it would be a win win situation for Russia.

While all the three large stake holders namely Saudi Arabia, USA and Russia would suffer due to the low price of crude oil, the worst sufferer would be Saudi Arabia, as it’s economy is almost entirely dependent on oil revenue, unlike USA and Russia. Certainly, Saudi Arabia cannot protect it’s economy , if the crude oil price in the global market would remain in the range of US$ 23 to 29 for length of time.

In all probability, the dust will settle down soon but may not be sooner than what Saudi Arabia would desire.

In taking the price war with Russia too far, instead of arriving at a compromise with Russia by reaching an understanding, it appears that Saudi Arabia has chosen to bite more than what it can chew.

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