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Energy Insights: Energy News: High-cost oil production not worthwhile

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High-cost oil production not worthwhile



Anjli Raval, Oil & Gas correspondent

epa03505671 The oil minister of Saudi Arabia, Ali Naimi , before the 162nd Organisation of Petroleum Exporting Countries (OPEC) meeting in Vienna, Austria, 12 December 2012. EPA/HERBERT PFARRHOFER

The oil minister of Saudi Arabia, Ali Naimi , before the 162nd Organisation of Petroleum Exporting Countries (OPEC) meeting in Vienna, Austria, 12 December 2012. EPA/HERBERT PFARRHOFER  ©EPA

Ali al-Naimi, Saudi Arabia's oil minister, expects the oil market ‘to stabilise itself eventually’

When the oil world’s most important man says anything, people pay attention. But the usually aloof Ali al-Naimi, Saudi Arabia’s oil minister, took market observers by surprise last week when he did something he would never normally do — talk the market down.

Sell, baby, sell

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Rather than instil calm as the price of oil fell to a five and a half year low of around $60 a barrel, Mr Naimi’s forceful and at times bellicose comments only gave those betting on lower prices encouragement to keep selling.

Opec, led by its largest producer and effective leader Saudi Arabia, would not be cutting output to bolster prices, said Mr Naimi, reaffirming the cartel’s decision at its November meeting to keep its output target at 30m barrels a day.

But he did not stop there. His comments, in a series of interviews, went beyond any official remarks.

Mr Naimi said: cutting production was no longer in the interest of Opec producers; the price of oil may never reach $100 a barrel again; even if non-Opec producers come to an agreement on cuts, the cartel would not now change tack; high-cost producers may try and hold out but the financing would sooner or later dry up.

Game on

Whether his words were simply “bravado” or an articulation of a well-thought out strategy the message was simple: those energy companies and financiers invested in any high-cost production, from US shale plays to output from Brazil’s deepwater fields, need to realise it is not worth the bother.

A person briefed by Saudi officials said the country’s national oil company has been told to prepare for at least two years of lower oil prices, something that kingdom’s finance minister on Thursday also alluded to.

Indeed, after releasing the 2015 budget, Ibrahim al-Assaf, Saudi Arabia’s finance minister, said: “We have the ability to endure low oil prices over the medium term” of up to five years, even if it means delving into fiscal reserves to cover a large deficit.

But Mr Naimi’s remarks that Saudi Arabia and other Gulf producers have an upper hand is predicated on a belief that they not only have the reserves and the spare capacity, but also the relationships with banks and access to financing that other producers — both within and outside of Opec — do not.

A big gamble

Less financially secure Opec members, from Iran to Algeria, have already voiced their concerns about Mr Naimi’s strategy saying it is a gamble.

Mr Naimi will also have to convince the Saudi population and domestic investors who have grown used to the benefits of higher oil prices, from rising property values to buoyant equity markets.

Most oil market watchers expect prices to rise eventually. While some say the second half of next year, others say 2016. Mr Naimi himself has said the price drop is “temporary” but what this means exactly is anyone’s guess.

Even if Saudi Arabia believes $60-$80 a barrel is an acceptable level for prices for the foreseeable future, what if prices drop much lower, hitting investments? The implication of prices going too far in the other direction as output falls dramatically is also unclear.

Risks to upside

Supply risks are still in focus. Let’s keep in mind that the oil market is oversupplied, but there is not the huge glut that was apparent in 2008-2009. Also, demand has slowed but has not fallen off a cliff. Add this to the outages in Libya (the fires that have raged in the African country’s main oil terminal in the past few days show geopolitical risk is still in play) or the fallout of any Venezuelan default and the impact of further oil price drops on countries from Nigeria to Russia and a different scenario could quickly emerge.

The Commodities Note is an online commentary on the industry from the Financial Times

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