Sanctions are Not the Biggest Economic Threat for Russia

Econintersect: Saudi Arabia has made a decison that is both tactical and strategic: In the face of falling oil prices they have decided not to cut production. Reducing supply would be a normal reaction for the world’s largest oil exporter if they wanted to slow the price decline and try to establish an early bottom for oil prices. But, according to energy expert Dr. Kent Moors, that is not the objective of the Saudis. Instead he says the Saudis are making a tactical decision to try to get prices of oil lowered sufficiently that competitive sources of crude (especially U.S. shale operations) will become uneconomical to continue production. Canadian tar sands bitumen may also be a target because a recent estimate was that WTI above $90 was required for the bitumen to compete.

Moors says that the target of the Saudi tactic is the surging shale oil production in the U.S. The production costs of oil obtained by fracking is high compared to compared to conventional drilling, which is what Saudi Arabia does. But collateral damage will also occur in Russia which needs $90 to $95 a barrel to support the national budget. Oil prices at $80 or lower could do far more economic damage to the Russians than the EU and American sanctions.

But back to the U.S., the following graph from Sam Ro at Business Insider shows that nearly half of current shale fields are unprofitable at $80 a barrel and he reports that the 50% point on a reserve weighted basis is $76 to $77.

If oil were to drop to $60 a barrel virtually all U.S. shale operations would lose money. Moors says that

Click for larger image.

In what might simply be a public relations oriented statement, CEO of Saudi Arabian corporation Saudi Basic Industries Corp. told reporters Sunday (26 October) that the decline in oil prices is temporary because population growth will ultimately boost consumption and therefore price. He specified that temporary might be a year ot even more. Canadian and U.S. production would likely react to lower prices well before a year passed and then there would be a lag in starting up again , if production ever did go back to current levels.

So, if Saudi Arabia has a tactical plan, it may turn out to be strategic as well. And based on reports from Reuters the Saudis have been telling people in the oil market that they will be quite comfortable with lower prices “for a year or two”, with $80 mentioned specifically. With production costs for Saudi Arabia running around $30 a barrel they hold winning cards in a price war.

John Lounsbury

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