The Last Barrel
In 2014, the U.S. shale boom was raging, and benchmarks were hovering around $100-$110/bbl. But Saudi Arabian oil minister Ali Al-Naimi sensed danger in U.S. shale development. To counter the game-changing threat, the Saudis unleashed a 1970s-style price manipulation policy. In spite of weakening demand and amply supply, the Saudis and their OPEC buddies elected to keep the spigots wide-open to protect their market share, rather than restrict production to preserve assets and support prices. They also offered deep discounts to their best clients. When prices plummeted, oil dependent nations, including Russia, Nigeria and Venezuela, had to increase production to compensate for the loss of export revenue, putting even more crude on an already saturated market.
Although it appeared the Saudis were targeting high-cost U.S. shale producers, the strategy also caused major damage to the riskiest and most vulnerable portions of the worldwide oil and gas industry. The targeted initiative, just like the 1970s oil embargo, proved that a Saudi-led OPEC can still force its will on crude markets, and in the process drove a stake into the heart of deepwater activity, and Arctic drilling. The price collapse and mounting regulatory pressures forced Royal Dutch Shell to terminate its offshore Alaska drilling campaign “for the foreseeable future,” at a loss of billions of dollars.
U.S. shale drillers, who had borrowed heavily on an expectation of continuing high prices, also suffered mightily in the ensuing bust. The plight of Chesapeake Energy stands as a classic example of unfettered greed (previous executives) and too much borrowed money chasing natural gas production, which has historically been a second-class citizen to King Oil, especially in the Mid-Continent U.S. In eastern Oklahoma during the early 1980s, wet-gas was trading for $0.25/Mcf, when the low-pressure/low-volume gathering system would take production. I know hindsight is 20/20, but what were those peak-guys thinking? Despite blatant mismanagement by the previous regime, current Chesapeake executives managed to stave off bankruptcy and keep the company afloat, with CHK stock trading in the $5/share range, but it’s 85% lower than its $30 price in 2014.
By 2016, global investment in oil E&P had shrunk 23%, but in North America, the decline was 38%. The shale industry had survived by driving down service costs. But the price reduction had caused shale players to proceed with caution and be more careful in future planning. So, the multi-faceted Saudi strategy seemed to have worked to perfection.
Plan starts to backfire. It’s difficult to understand now, how Saudi Arabia planned to manage the fallout from its manipulation of worldwide crude markets. Did they even have an exit strategy? Apparently not. In May 2016, Saudi Arabian oil minister Ali Al-Naimi “retired.” He was replaced by Khalid Al-Falih, minister of energy. He did an immediate about-face and called off the price war, and orchestrated an output-cutting deal with their OPEC allies and, most importantly, Russia. But before negotiations started, the Russians cranked up production to record levels, so they could just return to normal output, once the time came to reduce production. At the same time, Russia managed to take market share away from Saudi Arabia in one of its top export markets, China. Russia is now the major exporter to that country, displacing the Saudis.
Another casualty. In May, Oman announced plans to sell $2 billion of Islamic bonds to help trim a ballooning budget deficit caused by lower oil revenue, said Darwish Al Balushi, the country’s finance minister. In 2016, Oman’s deficit swelled to 22% of gross domestic product, according to the International Monetary Fund. With smaller oil reserves and less of a cushion in government savings, compared to its wealthier neighbors, Oman is one of the most vulnerable countries in the Gulf Cooperation Council (but not OPEC), as lower oil prices pressure state finances. But, according to Al Balushi, “We are confident that our economy is heading the right direction, because the government has taken several measures for economic and fiscal reform, including privatization and public-private partnerships.”
Powerful new alliance, finally. In spite of deep philosophical differences that put them on opposite sides of the six-year Syrian civil war, Russian President Vladimir Putin met with Saudi Arabian Deputy Crown Prince Mohammed bin Salman in Moscow, after their two countries agreed to extend the supply reduction for another nine months. The plan is to establish a permanent alliance between the world’s two largest oil producers. Although previous cooperation attempts failed, President Putin told Prince Salman, “We are grateful to you for your ideas and the joint work between OPEC and the countries which are not part of the cartel. The actions we agreed are helping to stabilize the situation on the world hydrocarbon markets.” Salman responded, “The relations between Saudi Arabia and Russia are going through one of their best moments ever. The most important thing is that we are succeeding in building a solid foundation to stabilize oil markets and energy process.”
After-action review. Saudi Arabia initiated the price war to bolster its leadership position in global oil markets and stabilize its market share. But as Al-Naimi’s initiative played out, the Kingdom’s leaders realized that the damage it was causing to their own economy was not worth the potential long-term benefits. It’s estimated that the gamble cost OPEC $2 trillion, with about one-third of the lost revenue suffered by the Saudis. But by ending the war and stabilizing prices, they can now concentrate on rebuilding their budget and diversifying the economy. Although it appears a “new normal” is underway, the question is, was it worth the destruction? 
