Investors in oil and natural gas saw world prices for fossil fuels decline even further with the latest action by Saudi Arabia. Oil is now at a lower point in price than has been seen in more than four years. The Saudis unexpectedly announced that crude sold in the United States from them would experience another price cut. As the world’s largest exporter of oil this decision puts added pressure on American domestic energy producers. The question on investors mind is at what point will further expansion of oil production in the United States will be threatened by these declining oil prices? An additional concern for many is what exactly is Saudi Arabia trying to accomplish?
The rapidly expanding energy industry in the United States is driven by new technology in the development of shale rock formations containing oil and natural gas. This new evolution in extraction known as fracking, has not yet experienced a market with declining energy prices. What is the break even point for the industry? The Saudis have already stated they are quite comfortable with the price of oil remaining at $80.00 USD (United States Dollar) for an extended period of time. Some energy resources will no longer be profitable to develop in the United States when the international price dips to a low of $76 to $77 USD. This is especially true with offshore drilling and remote areas on land.
Some analysts claim that Saudi Arabia is simply attempting to narrow the price differentiation between Brent oil which is the international benchmark, with WTI (West Texas Intermediate). WTI is the oil that is sold in the United States. The American oil market is more insular at this point, since United States production still cannot legally be sold overseas. The price of Brent is now down to $82.82 USD which is a 30% decline since June. WTI crude is currently being sold at $77.20 USD. This explanation does make some sense since the Saudis are only lowering the price of oil sold to the Americans by an estimated 0.45 USD a barrel. It is important to note that at the same time Saudi Arabia is increasing the price of oil per barrel sold to Europe and Asia.
Although since 2013 the United States has been the largest producer of oil in the world replacing Saudi Arabia, the country is still the largest consumer of oil. As a result, the United States still imports over 7 million barrels of crude daily, even as American production now exceeds 11 million barrels a day. In fact, American production has increased by 70% in the past 6 years.
United States imports of oil from Saudi Arabia continue to decline. They are rapidly losing market share in the American market. In August of 2013 as a share of consumption oil from Saudi Arabia was 7%. A year later is is down 4.6%. This autumn, crude imports from Saudi Arabia have now fallen below one million barrels a day as compared to 1.4 million barrels last year. Overall, the United States has cut imports from OPEC (Organization of the Petroleum Exporting Countries) by 50% since 2008.
Another issue for the energy industry in the United States is declining domestic demand. Where consumption had increased in 2013 to almost 500,000 barrels daily, it has declined nearly 40,000 barrels this year. Of course, lower prices will now encourage wider use once again.
Oil produced by fracking is not cheap. Depending on location and depth of extraction prices can range from $50 to $75 USD at the well head. This obviously does not include the cost of transporting the oil to market, first to the terminal and from there to the actual wholesale customer.
Annual investment in the oil industry for the United States has reached $200 billion USD annually.
Therefore, further declines in crude prices at this point will soon be below the cost of production for a number of sites around the country especially in North Dakota. Further exploration and development there, in the Arctic regions of Alaska, off shore and in numerous other locations no longer becomes economically prudent. It will slow down the further expansion in American crude and natural gas production.
Saudi Arabia can produce oil for as little as $30.00 USD at well head. So if the goal is to damage American producers of energy it can easily be accomplished.
Longer term, Saudi Arabia needs oil prices of at least $83 to $84 USD to balance its federal budget. The government has become very generous to the citizenry of the country over the years so these costs have become high. There are few taxes in the country to speak of. Free health care and education have come to be expected. Subsidized electricity, food, fuel and housing have become mainstays of society in Saudi Arabia. The government has bought political stability through public spending largesse.
In the meantime though, Saudi Arabia with foreign exchange reserves of $734.7 billion USD can take the hit, if it advances the longer term economic and foreign policy goals of the kingdom. It is important to note that the Saudis ran deficits from the mid 1980s to the late 1990s and can easily do so again.
There are some that may fear that the American government itself is involved in the collusion. Fracking technology is still quite controversial in the United States. It is widely known that the present American Presidential Administration is not exactly fond of the traditional energy producers of the country. Many individuals along with President Obama, would prefer that more investment be devoted toward the development of alternative and renewable energy production.
Another advantage to lower oil prices in addition to regaining market share within OPEC and elsewhere, is the damage it does to Iran a dangerous enemy to the Saudis and indirectly Russia. The government of Saudi Arabia views the expansionist foreign policy objectives of the mullahs in Iran with great apprehension. They fear the development of Iran as a nuclear military power. The leadership in Saudi Arabia is fully aware that the Iranians need oil to be well above $100 USD in order for them to balance their government budget. The Iranian oil industry becomes truly profitable when the price of crude hits $135 USD a barrel.
Increasing Russian adventurism in the region is something the Saudis would like to discourage as well. The Saudis much prefer the benign policies of the United States in the region. The Americans are always careful to protect oil interests and have been quite successful over the years, in defending the area of the Persian Gulf against outside intervention. American hegemony has always come at a relatively low price both politically and economically. The United States engagement in the region has usually been good for business, in that it continues to allow the oil to flow uninterrupted. The Americans have also allowed energy resources to remain in the hands of local governments of the Middle East.
Russian support of Assad in Syria and Iran make the Russians a strategic enemy to the royal family of Saudi Arabia. The Saudis are quite aware that a large portion of the Russian national budget is dependent on oil sales. The billions of oil revenue spent on defending the ruble and the declining Russian economy make less money available for Russian mischief in the Middle East.
Lower energy prices serve the interests of Saudi Arabia at this time in history. As the largest exporter of crude in OPEC, the Saudis have the prerogative to open the spigots to keep global prices low and their market share high, at least in the short term. Saudi Arabia alone produces about 1/3 of the total oil available through OPEC, which gives the kingdom immense influence within the organization. As the world’s largest exporter of oil with 9.7 million barrels being produced daily, the Saudis will continue to have enormous power over the supply of oil. Therefore, Saudi Arabia alone has the ability to manipulate the price of crude on a global scale. In the end, this effects prices of all energy resources.