Saudi Oil Production Doesn't Add Up

I’ve been scratching my head for a while at Saudi Arabia’s determination to pump as much oil as it possibly can. The official explanation — that the Saudis want to crush oil prices in order to protect their market share — just doesn’t make any sense.

And the implication that the Saudis want to crush U.S. shale production doesn’t make much sense, either.

The U.S. doesn’t buy all that much Saudi oil. That’s largely because most of our refineries are suited for heavier crude than what the Saudis have. In 2014, Canada was our biggest oil supplier, sending roughly a third of the 9 million barrels a day we import.

Saudi Arabia came in second, at a little over a million barrels a day. Mexico was third with a little under a million barrels a day. 

For comparison’s sake, the U.S. is expected to produce around 9.5 million barrels of oil a day this year.

So what’s the best Saudi Arabia can hope for? If we doubled our imports of Saudi oil, that would still amount to less than 10% of our current production. Does that sound worth it? Not to me…

What’s more, U.S. oil doesn’t really compete with Saudi oil internationally because we don’t export oil, just refined products like gasoline and diesel. Saudi Arabia is free to make whatever supply deals it wants with China or Europe without any interference from the U.S.

If the Saudis think they can crush U.S. shale with $50 oil, it shows they don’t understand the U.S. oil industry.

Our oil companies are not state-run. The U.S. government can’t say, “Oh, we’re going to lower our production levels.” Only individual companies can do that. 

And while U.S. oil companies are spending less to grow production levels, they have to keep pumping because they have bills to pay. And the simple fact is that most U.S. oil companies are profitable, even at $50 oil.

Now, it is true that low prices have forced a few marginal U.S. producers into bankruptcy. But even this might not have the effect the Saudis supposedly desire. The acreage from these bankrupt companies will likely end up in stronger hands that can produce more efficiently. 

If anything, the Saudi strategy might threaten its market share because low prices have ignited a push to legalize U.S. oil exports. Then U.S. oil would compete directly with Saudi oil on the open market.

I’m not sure how they didn’t see that coming.

$300 Billion Blunder

While it’s true that lower oil prices increase demand — and statistics bear this out in terms of increased driving, for instance — what’s the point from a selling standpoint if you’re making less money selling more product?

The old joke about “making it up with volume” certainly applies here. There’s a big difference between selling 9 million barrels of oil day at $100 and selling 10 million a day at $50. 

Bloomberg has reported that OPEC oil revenue will be below $1 trillion for the first time since 2010. Saudi Arabia’s revenue losses will be over $100 billion. 

Saudi Arabia has already had to tap its own foreign reserves by $65 (around 10% of its total) to meet its spending requirements. It will likely run a budget deficit of ~$165 billion this year. 

Also, the Saudis have announced a $4 billion bond sale to raise cash — the first since 2007. 

This makes absolutely no sense, not when you have the means to satisfy your budget needs completely at your command. 

China’s Slowdown

China represents another major flaw in the market share theory. As the world’s biggest energy consumer, China is obviously a significant market for any oil producer. And Saudi Arabia was offering China below-market prices for its oil.

I suppose Saudi Arabia thought the discount would make China a loyal customer. And Saudi Arabia was China’s biggest oil supplier in 2014. But that’s changed. In May, Russia sold more oil to China that the Saudis did. In fact, so did Angola.

Part of the reason Russia and Angola were able to boost their sales to China is that they will accept Chinese renminbi for payment. Saudi Arabia will only accept dollars.

Bloomberg reports that Saudi crude exports fell from 7.74 million barrels a day in April to 6.94 million barrels a day in May. And in fact, total Chinese oil imports in May were down 11% from May of 2014.

Part of the reason is that China’s economic growth is slowing. Another reason is that Saudi Arabia has reversed its discounting to China. Saudi prices for China hit a 10-month high in May — no wonder China started looking elsewhere for oil to buy.

The simple fact is, now that U.S. oil production is so strong, there just aren’t that many significant markets for big oil producers to sell to. Market share doesn’t matter right now, because the oversupply has made it a buyer’s market. China can demand discounting from its suppliers.

That’s probably why Saudi Arabia recently said it would be cutting its production in September. The cut is expected to be small, around 200,000 to 300,000 barrels a day. That’s a start, and don’t be surprised if the cuts are bigger. Because keeping oil prices this low just doesn’t make sense. All it’s doing is costing the Saudis billions of dollars in lost revenue.

I can’t tell you it’s time to run out and buy oil stocks. But that time is coming in the not-so-distant future…

Until next time,

Until next time,

Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.