Saudi Strategy Pushes US Shale Oil off the Energy Market

According to a report published by the International Energy Agency (IEA) on Tuesday, OPEC’s global market share in oil is poised to expand by 2020 as non-conventional oil producers are pushed out of the market. This baseline scenario envisages a 50$ a barrel price until 2017. Thereon, prices are likely to surge until they recover to $80 a barrel.

This is a baseline scenario, under which OPEC’s share of global supply will remain at 41% until 2020, thereafter surging to 44% by 2025. That share could rise up to 50% by 2040, given that in the short-to-medium term states with high potential may find difficulty attracted much-needed investment, such as Iran, Iraq, and Venezuela. Shortfalls in investment are already evident. Consultants Wood Mackenzie said in August that major oil companies shelved 46 large development projects, deferring $200bn of investments.

The IEA report confirms a Goldman Sachs Group in September, which projected that although oversupply could lead prices to tumble to even $20 a barrel, forcing US unconventional oil producers out of the market, the trend will be reversed in the second half of 2016.

The fundamental existential crisis for Saudi Arabia really began when the US was transformed from a net importer to a net exporter foroil and gas in 2011. Much of this success story was due to the improvement of shale extraction technology. To address this crisis, Saudi has viewed tumbling oil prices as a process that could help Riyadh to regain market share.Over the last two years, Riyadhhas essentially spearheaded an OPEC strategy designed to protect market share by increasing production, rather than cutting down to boost prices. Combined with demand deceleration from China, this strategy has started to work.

US producers will recover when prices surge, but will not immediately recover to production levels that can threaten OPEC market share, given anticipated market expansion. The small number of producers raises energy security concerns, particularly for Asia.

Given that this is a long-term strategy with short-term costs, the risks for Saudi Arabia are considerable. Until 2014, Saudi had a 2% debt-to-GDP ratio. This could be 33% by 2020. That level of debt is less than impressive and it comes in the context of very low yields. The kingdom could opt not to borrow and dip deeper in its foreign reserves. The fact that it does not is probably a sound strategic choice.

Nonetheless, oil accounts for about 90% of Saudi public revenues. Further weakening of oil prices would add pressure on the kingdom’s finances, which cannot politically afford austerity politics. In addition, the war in Yemen and aid to Egypt is adding on its mounting expenses in a manner that seems equally inflexible. Nonetheless, the baseline scenario is that Saudi has secured dominance in the oil market for many years to come and seems to have ample foreign currency reserves and a low debt level to withstand the pressure.

Unless, oil prices do not recover in line with the baseline scenario. Tuesday’s report has a second scenario of 50 dollar barrel market carrying on for more than five years. That will be too long, even for the Kingdom.