Why Do The Saudis Like Cheap Oil?

Why Do The Saudis Like Cheap Oil?

Why do the Saudis keep pumping oil despite the glut? The Saudis’ game is not about profit, but about market share.   

Why Do The Saudis Like Cheap Oil?
Why Do The Saudis Like Cheap Oil?

Saudi Arabia sits on tens of trillions of dollars’ worth of oil—some of the world’s easiest to drill and refine—and it doesn’t like the rise of competitors like North American shale. It also worries that high prices could speed the search for alternatives.

At first glance, it seems odd that they would pass up the chance to get all the profit they could from the kind of captive market that oil enjoys. When gas was $4 a gallon, people drove less, but they didn’t stop driving. The Saudi strategy is based on the longer-term concern that next time, more people might just stop driving gasoline-powered cars altogether.

Last month, Saudi oil minister Ali al-Naimi asked a conference, “Is there a black swan that we don’t know about which will come by 2050 and we will have no demand?”

Growing Energy Intensity means less oil demand in the long run
At the same time, the Saudis also want to make sure that when people do buy gas, it will have come from Gulf oil, not Canadian shale or deepwater wells in the Gulf of Mexico or Indian Ocean. And while it’s true that the growing economies of the BRIC countries will need more energy, it’s not that simple.

One chart energy economists like is Energy Intensity, the amount of energy it takes to produce a unit of change in GDP. Instead of dollars per barrel, think of it as barrels of oil per dollar (of per capita GDP). More efficient economies get a lot of GDP bang for their energy buck.

The problem for oil producers like Saudi Arabia (or Exxon-Mobil) is that the same countries that are growing are also getting more efficient. So after a while, their demand peaks and they start needing less oil, even though they’re continuing to grow.

That time isn’t far off. The International Energy Agency estimates the US will reach peak oil demand in 2019. And the BRIC countries may become efficient (and heavy users of alternative energy) more quickly than OPEC would like. China’s love of electric bikes is well known.

A time of transition
So one way of looking at (or past) the current oil glut is to see it as a transition from a time when fossil fuels had a near-monopoly and ever-increasing demand. Combine that with control of supply and you control much of the global economy. But now, the Saudis can foresee a time when they have to compete for a slice of a shrinking pie. Less demand and more competitors is a new situation for oil producers.

The break-even costs of the world’s major oilfields ranges between $35 and $75 a barrel. Clearly, the expensive drilling projects will become unaffordable very soon. Keeping prices low will force that to happen. It also discourages new exploration. New finds last year were the lowest in 60 years and that drop is likely to continue.

Russia and the Islamic State
There’s a secondary effect which, conspiracy theories aside, may be why the US and Europe are not complaining about the effects on western oil companies. Sure, they like offering cheaper gas to their citizens, but the US and Europe also don’t mind that low oil prices mean less money for Russia, which is essentially an oil company with an army, and ISIS, whose funding comes largely from stealing oil and selling it on the black market. They will let Chevron and Shell take a hit if it means keeping  Putin from further military adventures southward.

ISIS has openly called the Saudi royal family its enemies and sworn to attack Riyadh. Weakening ISIS’s ability to buy arms and recruit within Saudi Arabia while also boosting their market share is a win-win for the Saudis.

The Baker Hughes rig count at all-time low
In recent months, crude oil traders have started paying attention to a number which has been published every Friday for 71 years to little and often no notice. The Baker Hughes corporation—as in Howard Hughes, the filmmaker, Spruce Goose pilot, and oil baron—has published a count of active oil rigs every week since back when its co-founder was still trimming his fingernails. That number has experienced the largest drop in its history, losing an additional 48 rigs as of today.  

Why traders are so interested in this dubious number is unclear. Rigs vary quite a bit in their efficiency and technology. But the report has had the oil market jumping every Friday for weeks now, so much that some oil traders in Europe are complaining about having to stay late instead of starting their weekends.  

In the face of all this uncertainty, obscurity, and maybe even conspiracy, what can traders do? Limit your risk, follow the trend. Nadex binary options in crude oil let you do this consistently, no matter how volatile the oil market gets.

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