Are the Saudis Really Fine With $20 Oil?

The Saudis struck a defiant tone this week, insisting they’d be just fine with $20 per barrel oil. The FT reports:

“As a policy for Opec — and I convinced Opec of this — even Mr al Badri [Opec secretary-general] is now convinced, it is not in the interest of Opec producers to cut their production,” [Saudi oil minister Ali al-Naimi] told the Middle East Economic Survey.

“Whether it [the price] goes down to $20 a barrel, $40 a barrel, $50 a barrel, $60 a barrel, it is irrelevant,” he said. This was a strategy not just in response to the current oil price rout, but also for the future, he added.

In terms of the ability to pump oil out of the ground at $20 per barrel, the Saudi oil minister isn’t fudging facts. Saudi Arabia contains some of the world’s last reserves of conventional crude that’s relatively cheap and easy to extract. Contrast that with the U.S., whose energy renaissance has relied on more complicated techniques and, as a result, requires a higher price to remain profitable (American shale formations have widely variable breakeven prices).

But as a petrostate, the calculus isn’t as simple as whether or not the Saudis can profitably drill. Like the rest of OPEC’s members, Saudi Arabia’s government relies heavily on crude revenues—it needs oil prices of at least $93 per barrel to stay in the black. It can withstand a bear market for a time, but those budget deficits could eventually induce the Saudis to cut production to stabilize prices.

The Saudis decision not to cut production likely has two aims. First, it hurts their regional rival Iran more than it hurts themselves: Iran has a breakeven price north of $140 per barrel. Second, it hurts their new, out-of-the-blue competitors: American shale producers. Unfortunately for Riyadh, that second aim may be more difficult to achieve, as American frackers continue to improve drilling techniques and get more oil out of shale for less money and time.

Posted: Dec 25, 2014 - 11:00 am - JH