The oil minister of Saudi Arabia, Ali Naimi , before the 162nd Organisation of Petroleum Exporting Countries (OPEC) meeting in Vienna, Austria, 12 December 2012. EPA/HERBERT PFARRHOFER
©EPA

Cheaper crude is a holiday gift for consumers that is unlikely to stay

Ali al-Naimi, Saudi Arabia's oil minister, expects the oil market ‘to stabilise itself eventually’

As oil prices have plunged over the past six months, Saudi Arabia seemed to be flailing ineffectually against the tide of cheap crude unleashed by the shale gas boom in the US.

In the past week, the kingdom has made a determined attempt to dispel that impression.

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Ali al-Naimi, Saudi Arabia’s veteran oil minister, has set out a comprehensive and convincing analysis of the oil market and his country’s strategy, explaining its refusal to agree to production cuts at the Opec meeting on November 27.

“It is not in the interest of Opec producers to cut their production, whatever the price is,” Mr Naimi said in one interview.

His comments suggest that while Saudi Arabia may not be in control of events, it is making a deft attempt to turn the situation to its advantage.

The power of Opec has often been overstated. Apart, perhaps, from during its heyday in the 1970s, the cartel’s control over oil has been analogous to central banks’ ability to influence exchange rates: sometimes effective in nudging prices towards where they would eventually have gone anyway but doomed to failure if it tries to resist market forces for too long.

Mr Naimi’s argument, however, is that those market forces favour producers in the Middle East, which have some of the world’s lowest costs, over the more expensive shale industry in the US.

As he has explained, it makes no sense for the Saudis to curb their output to support prices because high-cost producers, in Russia, Africa and Brazil as well as the US, will be forced to cut first.

Mr Naimi’s message for the boardrooms of international oil companies, and the banks and fund managers that finance the US shale industry, is: you had better cut your investment and production because Opec producers will not.

US shale has been one of the first sectors to be affected because activity can be scaled up or down relatively quickly, and many companies were already in precarious financial positions even with the oil price at $100 a barrel. Share and bond prices have been tumbling, and the number of rigs drilling for oil in the Bakken shale region of North Dakota has dropped 9 per cent since its peak in October.

Harold Hamm, one of the pioneers of US shale oil, rightly observed this week that there is some “bravado” in Mr Naimi’s words.

Saudi Arabia also faces financial constraints and, although its large foreign exchange reserves mean that its projected budget deficit of about $39bn for 2015 is easily affordable, it will not want to repeat that shortfall indefinitely.

Whatever they do, the Saudis will not be able to kill the US shale industry. The oil is still there and production techniques are improving all the time. If the price of oil rebounds, so will shale drilling and production. Still, investors who have been burnt in the first wave of the boom are likely to demand clearer evidence that companies can be financially sustainable, and that is unlikely to be possible with crude prices at their present levels.

Oil prices may yet fall further before they recover but crude at $60 is not sustainable in the long term for either the shale barons or the Gulf sheikhs. Supply will have to be brought back into line with demand somehow, whether by a slowdown in the US or a U-turn from Opec.

Consumers have enjoyed a welcome holiday gift of cheaper oil but they cannot expect it to last for many years into the future.

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