Oil & Gas Management
An Analysis of OPEC's Pricing Strategy: Has Saudi Arabia underestimated the resilience of U.S. shale oil?
The global environment for oil and gas has changed significantly in just the last few years as a new set of market conditions have been created that can be defined by an increase supply in oil. These supply increases have largely come from technological developments that have allowed for new forms of oil to extract such as shale oil which has in turn reduced the dependence on the cartels and Middle Eastern oil (Doshi & Corrigan, 2015). There have also been changes in the demand due to technology development as well. Engines and efficiencies have reduced the total demand for oil per user despite the fact that the number of total oil and gas users have increased rapidly in the developing world.
The oil industry serves as the foundation for virtually the whole economy. New technologies have allowed the extraction of the oil that still remains in the U.S. Offshore drilling and oil reserves that are only accessible by hydraulic fracking represent the two best examples of controversial extraction methods. However, recently Saudi Arabia has decided to maintain production levels to keep the oil prices low as part of a strategic initiative to increase their market share. They believed that the lower prices would result in fewer U.S. competitors in the shale market due to smaller margins. This analysis will look into Saudi Arabia's strategy and the global oil market in general.
Background
Saudi Arabia has been subject to a significant amount of speculation regarding its decisions to reduce the production levels of OPEC since November 2014; by defying the international pressure to reduce production, OPEC has consistently exceeded its official production target of 30 million barrels per day since May 2014 (Agnihotri, 2015). When OPEC made the decision to maintain production levels in November 2014, the country did so in the face of a weak demand in the market. Saudi Arabia, which is the biggest producer in OPEC, produced 10.3 million barrels per day in September this year and has offered discounts to protect its market share in key regions to countries in Asia and India. It was also a move that could have hurt the U.S. shale oil producers since the lower prices in the market by the production levels could have put pressure on these operations by reducing their margins.
The move to keep OPEC's production at the current levels has been largely driven by competition. But at the same time it has also exposed some of the financial problems within the country. Saudi Arabia's revenues have been shrunk -- by an oil price that has more than halved -- yet the kingdom has a higher pain threshold than everybody else and it will continue with its long-term plan to undermine rivals and secure its market share (Raval & Kerr, 2015). But it is also considered a gamble that could last years, affecting the kingdom's economy far more than anticipated. The kingdom is starting to burn through the reserves that it uses for social spending and maintaining the economy.
Figure 1 - Saudi Revenues (Raval & Kerr, 2015)
OPEC's Strategy
In the face of falling global oil demand, it was largely at the behest of Saudi Arabia, who were driven by the desire to regain lost market share. This strategy was a gamble that U.S. shale oil producers could not sustain production levels at much lower prices. This strategy to decimate the U.S. shale industry has, had some mixed results. According to the data from Baker Hughes Inc. dated 20th February, the number of rigs for drilling oil is the smallest in the United States since July 2011; the figure fell by 37 last week to 1,019 as well as 556 were withdrawn from service since 5th December (Taneja, 2015).
"It is having the effect that we would expect, which is a decline in investment and ultimately supply, and somewhat higher demand. We think this change is for good"
Francisco Blanch, Head of Commodities Research at Bank of America
Within OPEC, other producers, principally Iraq and Iran, are determined to continue raising their output even as prices slump (Kemp, 2015).
"We will be raising our oil production at any cost and we have no alternative," Iran's Oil Minister Bijan Zanganeh said in a news story carried on his ministry's website.
There are also signs output growth from shale drillers and other producers outside OPEC is starting to slow, but it is not falling yet. Yet other reports indicate that the Saudi strategy will begin to take its toll on firms that have higher...
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