Who will break first, Saudi Arabia or the American shale oil industry?

VERSUS

Three fascinating articles to give some perspective on global oil market. Might want to get a fresh cup of coffee, this will be a long read.

From immediate appearances, Saudi Arabia is in financial distress because of low oil prices. On a longer-term perspective they are in extremely severe trouble. OPEC as an organization is essentially done. Entertaining to watch one writer tried to blow off all of the above information.

First, the immediate indication that Saudi Arabia is having serious trouble now.

8/5 – Financial Times – Saudi Arabia plans $27bn in bond issues – Saudi Arabia has already borrowed $4B in the bond market. They are floating ideas of borrowing $5.3B a month through the end of the year for an additional $27B debt.

With selling around 10.3M barrels a day at price of around $50 which produces somewhere around $188B a year, why are they tiptoeing back into the debt market?

Article says the country needs $105/barrel to balance the national budget. At 10.3M bopd that would be about $395B a year. That is a shortfall of about $210B every year or $17.5B every month.

Article says the country has drawn their foreign reserves down by $65B to $672B now from a high of $737B in summer of 2014.

Second, a very broad article that gives tremendous background and explains several of Saudi Arabia’s mistakes and why the regime’s long-term prospects are horrible. If you are actually paying attention to my comments on energy, this article is a must-read:

8/5 – Ambrose Evans-Prichard at The Telegraph – Saudi Arabia may go broke before the US oil industry buckles / It is too late for OPEC to stop the shale revolution. The cartel faces the prospect of surging US output whenever oil prices rise – I will rephrase and comment on a lot of ideas in the article.

Long-term futures contract point towards a price of $62 a barrel in December 2020. That puts Saudi Arabia, needing $105 a barrel to balance a budget, in extreme distress. A $40 gap in oil prices for the next five years would be devastating. Article speculates their foreign reserves are dropping about $12B a month.

At that rate they would use up their foreign reserves in about 4 1/2 years. It is quite a change to be calculating a burn rate for Saudi Arabia.

Article speculates their foreign reserves could drop to $200B by the end of 2018, a mere three years from now.

Article says Bank of America has categorized OPEC as

“effectively dissolved”

One of a string of mistakes is the Saudis thought dropping oil prices would curtail production from completed wells. What happened is the number of new wells has dropped. Even with my limited knowledge of oil today I know enough to realize that plan would never work. Even my negligible knowledge four years ago would have told me that scheme would fail. Any understanding of basic economics should have made that obvious. (Hint: if market prices are $50, do you keep producing if your incremental production costs are somewhere in the range of $5 or $10 or $15 a barrel? Even an American politician ought to be able to get the right answer on that question.)

Multiple paragraphs in the article make the point that I’ve realized before, specifically that shale oil is now essentially an on-and-off producer. In relation to the billions of dollars to get a major field going in the past and many years to start production, a shale well can be turned on with $6M and a month of time. I’ll guess cash flow payback is 6 or 18 months depending on IP. That’s a huge IRR.

Article points out that even if lots of drillers go under in the near term, neither the oil under the ground nor the wells above ground will go away. The drilling rigs will not disappear. The technology knowledge will not dissipate.

Someone else with more financial strength can buy up those leases & wells at pennies on the dollar and turn oil on again as soon as prices rise a bit.

That means new shale oil wells can come online fast which puts a cap on any rising prices.

Another strategic mistake was artificially keeping oil prices so high so long. Article suggests that provided cover for the shale oil industry to develop and mature. Aha – an interesting what-if scenario is if they had increased production and drop prices five years ago. Would the shale oil industry be anywhere near as strong today? Would fracking technology be as advanced as it is today?

Analogy made in the article is to shale gas. Since 2009 prices have dropped to $2.78 from $8. Number of rigs has dropped by 83% while production has increased 30%. Role that concept into oil and I will guess shale oil will moderate oil prices for a very long time to come.

Entertaining chart I have seen elsewhere shows the estimated oil price needed to balance the national budget for a variety of countries. A few examples:

• $40 – Norway
• $54 – Kuwait
• $105 – Russia
• $106 – Saudi Arabia
• $131 – Iran
• $160 – Venezuela

Compare that list of break-even prices to the $62 for 12/20 futures. Lots of countries are in serious trouble for the next five years if the futures traders are even close to correct.

Government spending in Saudi Arabia is unlikely to drop back anytime soon. Article points out a few features of their spending plan:

• War in Yemen against the Houthis is expensive and relies on imported weapons since the country can make none itself.
• Saudi Arabia is the fifth highest spender for defense in the world.
• They are providing lots of funding to others in the region who are also opposing Iran.
• Social spending is huge according to the article. Coronation bonus giveaway to all workers cost $32B. Gasoline is $0.12 a liter, or about $0.45 a gallon. Think I am paying more than that in taxes per gallon.  Price for a kilowatt-hour of electricity is a mere 1.3 cents.

Add to this their $7B buying spree of Patriot missiles to defend against the anticipated Iranian ballistic missiles.

So, in answer to whether Saudi Arabia as a country or the American shale oil as an industry breaks first, I’ll put my money on the shale oil industry to be the one that will survive and thrive in the long-term.

Finally, the third article provides amusement by explaining this is all a brilliant plan by OPEC and that the shale oil industry in the US will utterly collapse any hour now.

7/15 – Washington Post – How the plunging price of oil has set off a new global contest – Amusing read, especially if you are wishing the shale oil revolution would collapse really soon.

Here are just a few of the heavy-handed, wishful-thinking, biased spins in the article:

• U.S. shale oil is merely one item on a long, unspecified list of reasons why there is a glut of oil on the market.
• The companies in the shale oil field are collapsing in terms of their finances and infrastructure.
• Shale oil companies will likely not be able to gear up their activity if prices rise, since all the laid off workers went home and got other jobs.
• Shutting down American shale isn’t the biggest reason the Saudis increased production last fall – they merely got tired of subsidizing their high-cost competition in OPEC.
• In general, things are looking really grim for American drillers, who are maybe, possibly seeing a few minor productivity improvements.
• Oh, and that silly Harold Hamm, whose company has lost a third of its value, foolishly sold its futures contracts before the price drop, is losing money, and continues to shrink.

Yeah, that Harold Hamm – he still thinks we will see benefits from shale oil for fifty years and that shale oil is the best thing ever to happen here. I can almost hear in the on-line pixels the gales of laughter in the newsroom as the author of the column read his article to the other reporters.

After reading the article, you might expect the entire shale oil industry to collapse any day now. Fascinating read on how terrible things are in the collapsing frack industry that is cratering more every hour.

Maybe, just maybe, OPEC is the one cratering.

Update: some followup to the above articles.