Saudi Arabia Going Broke?

Jim Brown
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Saudi Arabia may have declared war on U.S. shale producers in hopes of running them out of business but they may have waited too late.

Typically when oil prices crash it is a short-term situation. The long-term outlook remains strong with futures several years out showing sharply higher prices. However, in today's markets the long dated futures are not that optimistic. The December 2007 WTI futures are trading in the $55 range with the 2020 futures at $62. Relatively speaking those are really low prices and do not suggest that the oil market is going to turn around any time soon.

Saudi Arabia has boosted its production to 10.6 mbpd and cannot seem to raise it any higher. For years they have claimed a 12.5 mbpd capability but we are not seeing production rise to that level. If there was ever a time for Saudi Arabia to increase production to offset the lower prices for crude this is it.

We are one year into the decline in oil prices and U.S. production is down only about -140,000 bpd from the peak of 9.61 mbpd we saw in June. Production is not declining as expected. In the recent earnings reports we learned that well costs were down 20-25% and Continental said they expect another 5-10% decline by the end of 2015.

U.S. shale producers are learning how to live with lower prices. Advanced drilling and completion techniques are allowing producers to drill 5-10 wells from the same pad with the wells branching out in different directions and into different formations. John Hess, CEO of Hess Corporation said they were lowering drilling costs by 50%. Pioneer Natural Resources said they were drilling wells today that take 16 days that took 30 days last year. Continental said they had the process from spud to total depth down to 12 days in the Bakken.

The active rig count declined more than 50% but enhanced completion techniques and multi-well pads are allowing producers to maintain existing production with less cost and fewer wells.

Saudi Arabia relies on oil sales for 90% of its revenue. Oil sales have been cut in half because of the drop in prices. The IMF projects a $140 billion budget deficit for Saudi Arabia in 2015. That equates to 20% of the Saudi GDP. Current foreign reserves are falling by $12-$15 billion a month. King Salaman is no longer a happy about his new position.

Saudi is now involved in a war against rebels in Yemen that will be very expensive to maintain. Saudi has no military manufacturing sector. All its weapons are imported. That is fine when oil is $115 a barrel but does not work at $45 a barrel.

To emphasize this point the Saudis are planning on selling $27 billion in bonds by the end of 2015. They have already sold $4 billion in the first sovereign issuance since 2007. The central bank has been testing demand for additional sales of about $5 billion a month for the rest of the year in 5, 7 and 10 year denominations. Analysts believe the country will continue the program into 2016 because of the outlook for oil prices. Brent crude has fallen from $115 to $50.

Back in November when OPEC or actually Saudi Arabia decided to open the valves and let prices decline it was in frustration. Saudi has been the swing producer for decades. If production needs to be cut it was Saudi Arabia that had to do it. The rest of OPEC would say they were cutting but then continue full production.

Saudi's oil minister tried to strike a deal with Russia to slow production in conjunction with OPEC. Russia refused. They are bleeding cash already because of sanctions over the Ukraine war. Saudi was also losing money as prices fell and they did not want to be the only country to cut production.

They made a mistake in underestimating the impact or actually lack of impact on the U.S. shale sector and other high cost producers around the world. Now they are in trouble. With Brent at $50 all the OPEC producers and Russia are deep in the red on their budgets and now they can't afford to cut production to raise prices even if they wanted to do it. They need every dollar they can scrape together.

Saudi Arabia requires $105 per barrel to balance the budget. Algeria needs $131, Iran $131, Nigeria $122 and Russia $105. Everybody always spends more money than they make and the same is true with countries. With oil over $100 for several years all the producing countries became complacent. Their budgets grew and became bloated because they expected oil prices to continue to rise. Now with a 50% drop they are all in trouble.

OPEC countries heavily subsidize oil products to their citizens. Over the next 12-18 months they will have to sharply curtail these subsidies or eliminate them all together. For citizens used to paying 25 cents per gallon of gas this is going to be traumatic. Saudi Arabia pledged $100 billion for citizens a couple years ago to keep them from rioting in the Arab Spring. When the king died last year the new king gave away $32 billion in gifts to workers and citizens to prove how benevolent he was and curry favor with the population. Doubling, tripling or even quadrupling their cost of gasoline is not going to win friends. There will be unrest.

Replicate this across all the OPEC countries and low oil prices are going to be painful in more ways than you can imagine and another round of citizen uprisings could easily be on tap.

Saudi Arabia is not broke but they cannot pay their bills without borrowing huge sums of money. Their daily income from oil sales has fallen from $1.22 billion to $530 million. That is a huge cut in inflows when your bills are based on the larger number.

Active Rigs

Active drilling rigs rose +10 to 884 for the week ended on Friday. Oil rigs rose another +6 for the week to 670. Active gas rigs rebounded +4 to 213. Active rigs have now declined -1,047 since the high of 1,931 in September. That is a -54% drop. Active offshore rigs rose +4 to 38 for a 7 rig gain in the last six weeks.

Oil Inventories

Crude inventories fell -4.4 million barrels to 455.3 million.

Refinery utilization spiked to the high of the year from 95.1% last week to 96.1%.

U.S. production rose +52,000 barrels to 9.465 mbpd, down from the 9.61 mbpd and 40-year high in June. Demand rose +313,000 bpd.

Cushing inventories declined slightly to 57.2 million.

Gasoline inventories rose +0.8 million barrels to 216.7 million. Gasoline demand rose +348,000 bpd.

Distillate inventories rose +0.7 million barrels to 144.8 million and a three-month high. Demand rose +150,000 bpd.

In the graphic below green represents a recent high and yellow a recent low.

Jim Brown

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