Saudi vs. Shale

A while back, a restaurant opened around where I lived and immediately began to attract customers with cheap and quality buffets deals that were too good to be true. However, there was an existing restaurant in the area that also served a similar style of buffet. The two engaged in aggressive price wars and soon enough, one of them went out of business. Now, the “winner” is serving the same buffet deals with lower quality food, for three times the price. This type of behavior, where a business stomps out the competition by hurting itself at first but then reaps huge benefit of being a monopoly, is quite commonplace.

What’s happening with Saudi Arabia’s oil industry with America’s shale corporation is in many ways, similar. Well, they both serve the one same dish: oil.

Since mid 2014, there has been an oversupply of crude oil due to a number of reasons including: increased supply from shale drilling, OPEC’s decision to maintain production, and slowing growth of  oil consumption in India and China. These events have pushed oil prices from well over $100 per barrel to less than $50. Within this is the ongoing battle between Saudi Arabia, OPEC’s biggest oil producer, and its competitors, which include North American shale drillers.

In recent years, high oil prices have attracted investments into shale drilling, a high-cost production method that allow oil to be extracted from shale deposits. However, this requires oil prices to remain high in order to be profitable. Saudi Arabia’s oil fields do not require this technology, thus their oil is much cheaper to produce. As a result, Saudi Arabia has an edge should a price war occurs, and it has.

In an interview with CNN, Saudi oil minister Ali al-Naimi said he wasn’t conspiring to take out rival producers by driving down the price. But added that Saudi Arabia will never cut oil production. However, Saudi prince and billionaire Alwaleed bin Talal contradicts this in a separate interview that, one “positive side effect” of the oil crash is it will allow Saudi Arabia to see “how many shale oil production companies run out of business.” Clearly Saudi Arabia is hoping that it can outlast shale companies, which are already suffering heavy losses. It is worth noting that the oil industry is one with some of the highest entry barriers. It will be unlikely for new companies to emerge once existing ones fail. Furthermore, investors will be dissuaded from oil in fear of the current price war repeating. It will be hard for new suppliers of oil to reemerge.

On the other hand, oil consumption remains at an all time high. InsideClimate News reports that America is still a glutton for oil. Cheap oil prices have also lured consumers away from gas efficiency.

So, once the competition are beat. What kind of oil prices will we be looking at? I think it is only a matter of time before we see $200 per barrel.

In any case, that one restaurant is still always packed with customers every time I go.

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