- Saudi Arabia slashed its forward price on crude, bringing the cost per barrel to under $40.
- Panic has now gripped the U.S. shale sector over worries that the industry will collapse.
- This isn’t Saudi Arabia’s first attempt to cripple a leading threat.
Saudi Arabia’s decision to cut oil prices has raised concerns that U.S. shale oil producers won’t survive the price war that has been triggered.
This view has gained credence given the existing market conditions – a supply glut coupled with a demand shock.
Before the drastic decision, Saudi Arabia and Russia had failed to agree on production cuts. The coronavirus epidemic has additionally reduced demand as economic activity around the world slows.
Saudi Arabia may have the upper hand right now, but the kingdom is unlikely to kill its U.S. competition.
Saudi Arabia’s low break-even cost isn’t enough
The argument goes that the ultra-low costs Saudi Arabia enjoys to get oil out of the ground will drive U.S. shale producers out of business.
Last year, Saudi Aramco disclosed that its average cost of production per barrel was $2.80.
That Saudi Arabia’s low break-even price, coupled with a drastic reduction in crude prices, will destroy U.S. shale is laughable. Rather, the oil price war will weed out inefficient producers, replacing them with frackers that are able to adapt to a highly competitive environment.
Some shale producers will no doubt close shop. Others will become leaner and meaner and ride out the storm.
Second time will be a failure too
In 2014, the same argument was advanced. At the time, U.S. shale oil producers required a breakeven price of $69 a barrel. In early 2016, the price of a barrel fell to under $30 but U.S. shale oil producers didn’t stop pumping. What happened? Frackers continued to innovate, lowering their break-even price to around $40 per barrel.
Now with Brent below $40, there’s still room for improvement. Ways of cutting costs and increasing efficiency include restoring offline wells, increasing the speed of production and boosting uptime.
In a report released last October, McKinsey & Company noted that reducing the time it took to repair wells offered high returns at low risk.
Additionally, shale formations with the cheapest production costs will attract frackers. For instance, the average break-even price in Montana and North Dakota’s Bakken shale formation is $29, a figure that is below the U.S. average.
Saudi Arabia‘s weak hand in war against U.S. shale
Saudi Arabia’s strategy is likely to get undone by its over-reliance on oil exports. While the Middle Eastern country has made progress to diversify its economy, its fiscal cushion is in worse shape than it was in 2014.
It is preposterous to argue that the oil price war that the Saudis have triggered will kill the U.S. shale industry.
U.S. shale oil resources will not evaporate just because there is a price war. The resources will remain waiting for meaner, leaner and more technologically advanced producers. This resilience has been exhibited before, which allowed the U.S. to become the world’s leading oil producer in the third quarter of 2018.
During the same quarter, the world’s largest economy became a net petroleum exporter for the first time since 1973 when monthly records started.
Disclaimer: The opinions expressed in this article do not necessarily reflect the views of CCN.com.