Saudi Arabia Takes the Gloves Off: Moment of Truth for US Shale Has Arrived

Mark Lewis, Senior Analyst Sustainability Research
and Coordinator Energy Transition & Climate Change, has written an article about the situation of oil market.

He says that despite the dramatic recent fall in oil prices, OPEC decided to maintain its current production quota of 30mbd, thereby compounding market fears of a short-term supply glut and prompting a further sharp drop in the Brent and WTI benchmarks (both down 6.3% on the day to $72.8/bbl and $69/bbl respectively). Our long-term view on prices remains unchanged (we think supply constraints will ultimately force prices onto a higher and rising long-term price trajectory from 2017 onwards), but we now expect prices to be much weaker in the short-term than we were previously assuming. If the Saudis really are looking to take out a material chunk of the US shale industry – and after yesterday’s decision we think they are – then we think Brent prices of $60/bbl are possible in the short term (within the next 3-6 months).

Oil prices have been crashing since June, and fell very sharply after OPEC’s decision not to cut. Saudis want to re-assert authority over the oil market: In our view OPEC’s decision should not have come as any surprise to the market. This is because it has become increasingly clear over the last two months that Saudi Arabia sees current price weakness as an opportunity to re-assert its authority over the oil market, an authority that has been increasingly questioned in the last three years with the surge in US shale-oil production. Indeed, we think  OPEC’s decision to maintain current production levels reflects both (i) Saudi Arabia’s pre-eminence within OPEC (it is inconceivable for OPEC to cut production without the Saudis’ taking the lead), and (ii) the Saudis’  determination to put the squeeze on the US shale-oil industry.

With OPEC not now due to meet again until 5 June 2015, the market has six months to wait before the Organisation’s next scheduled review of the supply-demand balance. It is true that OPEC’s press release made reference to the group’s “readiness to respond to developments which could have an adverse impact on the maintenance of an orderly and balanced oil market” (and hence to the possibility of an extraordinary meeting before 5 June should prices continue to fall too far too quickly), but we think the plain fact now is that unless or until the Saudis decide to cut production, prices will remain under pressure.

So, why do the Saudis hold the key to OPEC action?:  The Saudis hold the key to OPEC action because only they can afford to make the kind of supply cut that would actually make a difference to the market balance.

Conclusion: long-term view unchanged, short term view now more negative:  As we re-iterated in our Alert of 13 November (No Recoil from the Toil for Oil), we remain of the view that over the long term supply constraints will force prices onto a rising trajectory, with prices back at $100/bbl  by 2017 and rising in real terms thereafter.