As we enter year 3 of this big giant mess of an energy industry, I feel myself compelled to put on my Saudi Arabia hat and ask myself – has it all been worth it? Sometimes a little introspection is important especially because I believe that Saudi Arabia needs to own up the abject failure of its strategy, not that I have any strong feelings about this or anything.

 
I don’t say that lightly and I know that many will dispute this given the state on the energy industry. However, if you take a step back and look at what so many people theorize that Saudi Arabia was trying to accomplish with this strategy and then assess them on certain national objectives such as financial, market share and civil/regional/geopolitical stability it is hard to see how it can reasonably be said that this strategy is a rousing success.

 

On the other hand, I guess if the Saudi strategy was to needlessly spend $300 billion, destabilize it’s already fragile political situation and bankrupt Venezuela, then AA+.

 

So, why the negativity?

 

Mainly because no matter how I look at it, whether it is market share defence, squeezing tight oil producers or marginalizing Iran, the strategy hasn’t worked and there was arguably an easier way to achieve the desired result. All that has been accomplished is a massive destruction of wealth and goodwill and no one is further ahead, arguably everyone around is a loser. And the longer it continues, the worse it gets.

 

So, now that I have clearly made up my mind, time to build the argument.

 

I guess the best way to assess success is on three main fronts – financial, market share and geopolitical. Namely – as a result of the removal of quotas, is Saudi Arabia better off financially, have they protected or enhanced their market share and are they more secure geopolitically and measure that against some of their presumed strategic reasons for pursuing this strategy.

 

First stop is some of the pet theories everyone has for the Saudi plan.

 

Squeezing tight oil and market share defense

 

Since August of 2014, output in the US has gone from 8.630 million barrels a day to 9.218 at the end of August 2015 to 8.488 million barrels a day at the end of August 2016 or 142 thousand barrels a day less than two years ago – a rounding error. On top of it, production appears to be stabilizing in the US and may in fact grow in 2017.

 

Canadian production has been steady over that same period and is projected to grow, with or without pipelines.

 

Russian production is at record levels.

 

North Sea production appears to have levelled off.

 

OPEC production is currently at about 33 million barrels a day and Saudi production is about 1 million barrels a day higher than 2014 and factoring in growth in consumption since 2014, OPEC and Saudi Arabia’s market share is slightly higher but not materially so.

 

Over the same period, the Saudi’s drew down (squandered) approximately $300 billion in reserves.

 

So congratulations to Saudi Arabia, you have bankrupted hundreds of companies, sent entire countries to the brink of anarchy, half emptied the cookie jar you were bribing your citizens with and you have managed to change virtually nothing. And all it cost you was $24 billion a month for 24 months. If this is the type of economic calculus that passes for deep thinking in Saudi Arabia, I am, shall we say, perplexed.

 

What about marginalizing Iran?

 

That’s an excellent theory about the Saudi motivation and one I completely buy into being a goal all along. After all, cheap oil would economically cripple a regional rival and establish Saudi dominance.

 

Well let’s see how the last two years have unfolded on that front.

• Iran signed the nuclear deal that allowed economic sanctions to be removed
• Iranian export production has been restored to pre-sanction levels, so no matter where prices were, this is an economic windfall.
• The oil and gas sector is being reformed and opened up to investment
• The Iranian economy, which is much more diverse and less reliant on oil and gas than its Middle East rival is expected to be one of the fastest growing in the region
• Iran and Saudi Arabia are fighting proxy wars in Syria and Yemen
• Iran is engaged in rapprochement with Russia while Saudi influence in the United States is on the wane
• Civil unrest in Saudi Arabia is on the rise as deep budget cuts are implemented to offset the massive drawdowns in reserves resulting from the oil price decline and unemployment soars

 

Not the classic definition of geopolitical success.

 

So could they have done it differently?

Possibly. My own pet idea? In 2014 they should have maintained the OPEC quotas and let the rest of the market market shoot itself in the foot, because it always does. Seriously, the wheels were already coming off the patch in North America and we all know it.

 

There is nothing as self-defeating as an energy feeding frenzy and that is what was occurring. Left to its own devices, the tight oil market would have self-destructed on its own, the victim of too much leverage, too much hype, too much drilling and at the end of the day too much negative cash flow.

 

Even the EIA, the most bullish production forecaster out there said that tight oil drilling would peak in 2020 and then enter a steep decline thereafter. Are you telling me that Saudi Arabia, with its monstrous oil reserves and (then) $800 billion in cash couldn’t have waited that out? Seriously, trust in greed and human nature and you can almost never lose.

 

So then, rather than being pre-occupied on the energy front, they could have turned their attention back to what they really need to do for existential reasons – cosy back up to the United States, work to shore up regional allies to counter the inevitable Iran resurgence and start to beat back the regional threat that is Iran from a position of financial strength.

 

It would have been way less costly. And in all likelihood more successful.

 

So can it be fixed?

It’s tougher now and the pundits have the boy who cried wolf thing down pat but there is an out, but it requires them to acknowledge their error and actually do something.

 

As we all know, the Saudis have been talking up the price with speculation about a production freeze and a cap and all that fun stuff for more than a year now, but it’s all been orchestrated hot air. But now is the time for OPEC to do something on the production side, either at this informal meeting or the next formal one because nothing has been solved. The non-OPEC producers have it figured out now and aren’t going to cede anymore ground and there isn’t enough spare capacity in OPEC to win this in a war of attrition. OPEC is however in a position to proactively reposition the market to their benefit by thinking strategically.

 

Think about this for a second, completely hypothetical scenario that will likely never happen, but indulge me. If OPEC dialed back its production by say 10% for 3-6 months, it would go a long way to solving some of the inventory overhang (3 million barrels times 90-180 days less the 1.3 million barrels a day of global overproduction is 150 million to 300 million net barrels less in inventory assuming consumption is constant). Granted, those barrels would cost OPEC about $15 billion in receipts (assuming $50/bbl), but going forward the market would be in balance and we would likely be looking at $60+ oil, not too hot and not too cold with the storage balance acting as buffer to over-production. The market would freak out and prices would be volatile for a while, but that is mostly noise about the fringe – the time to act is long past.

 

I suppose the alternative is to keep going as we are going, filling up inventory and starving investment until the half a trillion dollars in reduced upstream capex and lack of new finds catches up and initiates the next oil price shock, likely triggering further global economic stagnation, if not recession, but I prefer to think that that is not in anyone’s best interests, although I doubt it will happen.

Prices as at September 16, 2016 (September 9, 2016)

• The price of oil ended the week down slightly as negative supply news dominated the news cycle.
  • Storage posted a surprise decrease
  • Production was up marginally
  • The rig count was up
• Natural gas was up during the week on weather and storage numbers

• WTI Crude: $43.03 ($45.88)
• Nymex Gas: $2.948 ($2.797)
• US/Canadian Dollar: $0.7570 ($ 0.7675)

 

Highlights

• As at September 9, 2016, US crude oil supplies were at 510.8 million barrels, a decrease of 0.6 million barrels from the previous week and 54.9 million barrels ahead of last year.
  • The number of days oil supply in storage was 30.5, ahead of last year’s 27.8.
  • Production was down for the week at 8.493 million barrels per day. Production last year at the same time was 9.117 million barrels per day. The change in production this week came from an increase in Alaska deliveries and a slight rise in lower 48 production.
  • Imports recovered to 8.062 million barrels a day, compared to 7.189 million barrels per day last year. It is hard to make any headway on US inventory numbers if the US is a dumping ground for everyone’s oil (aside from Canada’s of course)
  • Refinery inputs were high during the week at 16.730 million barrels a day
• As at September 9, 2016, US natural gas in storage was 3,499 billion cubic feet (Bcf), which is 9% above the 5-year average and about 6% higher than last year’s level, following an implied net injection of 62 Bcf during the report week.
  • Overall U.S. natural gas consumption rose by 4% during the week on increased power consumption
  • Production for the week was flat and imports from Canada rose11%
• As of September 13, the Canadian rig count was at 117 (17% utilization), 74 Alberta (16%), 10 BC (13%), 32 Saskatchewan (28%), 1 Manitoba (7%)). Utilization for the same period last year was about 25%.
• Oil rig count at September 9 was at 416, up 2 from the week prior.
  • Rig count at January 1, 2015 was 1,482
• Natural gas rigs drilling in the United States was down 3 at 89.
  • Rig count at January 1, 2015 was 328
• US split of Oil vs Gas rigs is 82%/18%, in Canada the split is 52%/48%
• Offshore rig count was up 2 at 20
  • Offshore rig count at January 1, 2015 was 55

 

Drillbits

• Anadarko purchased Gulf of Mexico assets from Freeport McMoran for $2 billion
• The massive $50 billion Kashagan oil project in Kazakhstan was expected to finally start up. There is some debate as to whether it will achieve achieve full production in a timely fashion
• The Obama government blocked construction on a major Bakken pipeline project, even after a judge ruled it shoud proceed, responding to the tyranny of the few…
• Libya appears to be close to a resumption of oil exports after a deakl was struck betwen one of the warring factions and the NOC to guarantee port access. It is expected that up to 400,000 barrels a day of output could be added within four weeks
• Chinese production is off significantly this year as the Chinese government shutters old and expensive to exploit fields in favour of cheaper imports (umm, hello Canada?!?!)
• Tervita, a Canadian energy service company announced its intent to restructure some $1.5 billion in debt
• Drumpf Watch – This week, Donalfd Drumpf was on the Dr Oz show to discuss his health (LOTS of testosterone) and delivered a letter written by his hippie gastroenterologist (not the results, a letter. Not his GP, a digestive specialist). The results were kinda hard to swallow. He also released his economic “plan” – lower taxes, an impossible amount of new great paying jobs and deductibility of child care and, federally mandated maternity leave! No costs, not feasible, but something. I suppose the strategy is really “if I don’t release any policy, there is no way Hillary can beat me in the debate becasue we’ll have nothing to talk about aside from her having pneumonia”.