Episode 8: Saudi Arabia as swing producer and Saudi Claims of Increase Production: Why you should care?

Summary:

 In this episode we analyze Saudi Arabia's recent announcement to increase oil production. We highlight how this decision seems to have been made without OPEC+ consensus, is a "punitive" move and how it may be interpreted as a move to try to discipline US shale producers, who have been overproducing oil. Is Saudi Arabia, frustrated by the US shale industry's lack of price coordination and inability to reach a $100 barrel price goal, attempting to lower prices to force American producers to curtail their production? We highlight the significant difference in break-even costs between US shale oil and Saudi Arabian oil, suggesting that Saudi Arabia is willing to take a hit to its own profitability to achieve its objective.

 Questions to consider as you read/listen: 

1. What are the key factors driving Saudi Arabia's decision to increase oil production?
2. How will Saudi Arabia's production strategy impact the US shale oil industry?
3. What are the potential consequences of Saudi Arabia's move on global oil markets?

 Long format:

 Saudi Arabia as swing producer and Saudi Claims of Increase Production: Why you should care?

 Today (October 18) news reports abound with the announcement by Saudi Arabia to increase its production levels.

 For as far back as for all practical purposes, Saudi Arabia has been a “swing producer” of international crude. You can think the Shah of Iran for this. The Shah of Iran was a man that was known far and wide for his enjoyment of the fine things in life. The fine things in life are quite expensive. There was never a period of under production in his reign. If one wants to control the price of crude, one must control production. In 1982, Saudi Arabia fully embraced its reluctant role as swing producer. 

 Prior to the shale revolution, and also the discovery of outside of the Middle East large deposits like those in the now being shuttered North Shore of the UK and in the now over producing American shale sector, OPEC and eventually OPEC+ were the dominant players in the crude market. It is only recently as measured by decades that oil prices were segmented into the dozens of individual spot prices that we now have today due to the diversity of global choice due to diverse production areas (and sweet versus sour choice)

 A swing producer is a supplier that can increase or decrease production of a commodity at a low cost, and can use this to influence prices and balance markets. Ever since the formation of OPEC, Saudi Arabia has reluctantly found itself in this role. Saudi Arabia is a swing producer because of its large oil reserves, its large share of global oil production, and its position as one the world's largest POTENTIAL petroleum exporter. Keyword is potential. Saudi Arabia's oil and gas sector accounts for about 50% of its GDP and 85% of its export earnings. If Saudi Arabia “takes one for the team” and underproduces while others don’t concomitantly reduce, it hurts. They feel it. 

 Now I don’t hang out with MBS or Prince Abdulaziz bin Salman but I know through one degree of separation folks who do. 

 This move to produce and produce punitively is being done so far without the “blessing” of OPEC+ as I understand it. I could be wrong but that’s my information. 

 Those folks I know who know folks say that people (not necessarily MBS or the Prince) that the people who swim in that circle have been really fed up with a lot of things. The complete blow up of the normalization of relations with Israel. The internal hardening of factions. The Israel-Iran thing. And never being able to hit $100 barrel price goal. But most importantly, they are quite upset with US shale producers. 

 This move by The Kingdom from “swing (producer) mode” to what is technically referred to as “punitive mode” where Saudi Arabia increases production to punish other producers and re-establish its position in the market is largely due to frustration not so much with its neighbors as it is with American shale. This is what I’m told anyway. 

 As I see from reports and published production rates, the compliance by OPEC+ countries to the set agreed upon production limits is as good as it has ever been historically. 

 https://oilprice.com/Energy/Crude-Oil/This-Is-About-As-Bearish-As-Oil-Has-Been-Since-the-2008-Financial-Crisis.html

 And guess what? Even as a small time US NOWI, I agree with him. The US is overproducing. 

 Why can’t America discipline themselves? 

 God I would love it if we could. But meetings among companies to manipulate prices is strictly prohibited under US antitrust laws, meaning any coordinated effort to fix crude prices could face legal action from regulatory bodies like the Federal Trade Commission. The diverse nature of the shale industry with many independent players really hurts any non coordinated action. Recall, according to available data, major oil companies produce a relatively small percentage of US oil, with independent producers contributing significantly more; estimates suggest that major oil companies account for around 17% of total US oil production, with independent producers responsible for the remaining majority. Just ask Scott Sheffield how real this potential FTC and criminal case for colluding can be. (https://amp.cnn.com/cnn/2024/05/02/energy/oil-ceo-opec-scott-sheffield)

 PZ’s analysis of domestic (American) break even points is correct generally. I can give you the average break even points for my 9 wells. I have two others fully drilled but not fracked and therefore no free flow because of futures prices. 

 The notion of break even point does not have a standard definition in the industry. It depends if you include the start up costs and how or whether you amortize them as laid out in the AFE (completion cost report) or not. It depends on if you amortize artificial lift. Do you include the very handsome tax write offs of tangible/intangible costs?

 The average break-even cost for US shale oil which is in my experience as low as $25-35-45 per barrel and on the upper end of that when it is a legacy or vertical well or if artificial lift is used. So it’s low. 

 For comparison according to a May of 2023 report of the International Monetary Fund forecast the Saudi Arabia’s breakeven oil price at $80.90 per barrel. In 2023, the Russian budget assumed a breakeven price of $70.1 per barrel for Urals. In 2022, Bahrain's breakeven external oil price was $39.38 per barrel, and in 2024 it was projected to be $45.70 per barrel. In 2022, Iran's breakeven external oil price was $48.79 per barrel, and in 2024 it was projected to be $44.11 per barrel. In 2022, Iraq's breakeven external oil price was $75.68 per barrel, and in 2024 it was projected to be $76.54 per barrel. In 2022, Kazakhstan's breakeven external oil price was $65.78 per barrel, and in 2024 it was projected to be $96.18 per barrel. ( https://prosperitydata360.worldbank.org/en/indicator/IMF+MCDREO+PZPIOILBE_B_USD )

 So Saudi Arabia is Walmarting the US shale play. Just like when Walmart comes into a small town, they are taking a hit to their profitability driving price down to the level where no reasonable NOWI or operator will drill a new site or where no reasonable NOWI or operator will invest in artificial lift. US shale is going to be getting a hair cut. 

 Each horizontal well costs about $5m on the AFE to drill to free flow. It takes us 2 months or so to get the drilling rig on site once ordered depending on how much demand there is. From spudding to free flow is 2-3 months. But there’s also a period of time (weeks) to get the frac fluid out to get to volume production. So it’s not overnight. 

 While yes the operating costs you get on the JIB after free flow does drop off, the rate of flow does too quite a bit. After about year 2 or so, it just sinks. 

 Here’s a pretty good production chart:

https://www.energy-cg.com/USA/Wyoming/PRB/Unconventional_LTO_prod_well_exam11_plot_1x1_EnergyConsutlingGroup_web.png

 Don’t just take my word for it, here’s a good study to consider. 

 https://www.energy-cg.com/economicsofshaleplays.html

 And it’s this precipitous drop off that causes us to use artificial lift products (the pump jacks y’all think of when think of an oil field is indicative of an older oil field that’s past free flow, Electric submersible pumps (ESPs), Progressive cavity pumps (PCPs), condensers, artificial gas lift like CO2 or water, etc). But no rational person will invest in artificial lift when the price is low.

 In my opinion (and that’s all it is an opinion) and for what it’s worth, this seemingly unilateral move is motivated to some degree to try to force discipline on the US shale market. Is it the prime motive? Dunno. Probably not. But is it a factor? Absolutely. 

 The open question what actual impact will this have in the WTI futures market and what will people like me do?

 Right now, I hear words (and yes they have me thinking) but I look at the futures market and see it “only” down to $67.91 for July 2025 right now. https://www.marketwatch.com/investing/future/cl.1

 Hedging or let it run? Dunno. Fun stuff.