The Oil Price War
The Saudi price cut is a game-changer. Here’s what it means for our markets, the loonie – and for you
Perhaps the single most important indicator for the short-term future of the Canadian stock market and the loonie came last week from halfway around the world. On Nov. 4, Saudi Arabia revealed that it intends to cut the price charged to North American customers.
The news sent the price of West Texas Intermediate (WTI) crude to a three-year low, savaged Canadian energy stocks, and knocked the loonie to below US$0.88, a level it hadn’t seen in five years. The oil price rallied somewhat later in the week but it is still well below the US$80 level.
According to Bloomberg, Saudi Aramco, the state-owner producer, cut prices by between $0.45 and $0.50 per barrel (figures in U.S. currency). That followed a previous, less noticed cut to Asian buyers last month. Bloomberg quoted Iraqi Oil Minister Adel Abdul Mahdi as saying that OPEC members have embarked on a “price war” in the face of a growing world oil glut created by rising U.S. production and slow growth in international demand. On Thursday, OPEC issued its annual World Oil Outlook in which it predicted “a small decline in real values” in the oil price over the rest of this decade. Having said that, the report forecast a constant nominal price of $110 a barrel between now and 2020. Of course, that is well in excess of the current price.
The Saudis have good reason to worry.
According to the Energy Information Administration, Aramco’s exports of crude oil and petroleum products to the U.S. fell from an average 1.5 million barrels a day (bbls/d) in 2008 to 834,000 bbls/d in August of this year. The reason is obvious: booming shale oil production in Texas and North Dakota plus increasing Canadian output have reduced America’s dependence on foreign oil to the point where the country is approaching self-sufficiency.
But the Americans have a problem: production costs of shale oil are high. According to a report in USA Today, analysts estimate that if the oil price drops below $70-$75 a barrel, it will uneconomic to invest in new wells. Even some existing producers may have to scale back or shut down.
On the face of it, the Saudis can easily win any price war. Their production costs are the lowest in the world, variously estimated at between $10 and $30 a barrel. The country has the largest reserves of light, sweet crude on earth. A Saudi oil official has said that his country could live comfortably with $80 oil for the next two years if it meant recapturing market share.
The $80 price may turn out to be on the high side in the face of sliding demand. Last month the International Energy Agency (IEA) reduced its 2015 estimate for oil demand growth by 300,000 barrels per day (bbls/d), to 1.1 million bbls/d. The IEA also said that oil prices would remain under downward pressure because of supply increases. Reuters quoted the organization’s chief analyst as saying that OPEC no longer has the clout to influence pricing dramatically because of the U.S. shale oil boom.
The Saudi dilemma goes beyond slashing prices to try to undercut U.S. production. The Saudi government relies on oil revenue to provide healthy financial subsidies to its citizens and maintain order in what by Western standards is an oppressive society. While Aramco can remain highly profitable even with deep discounts, the hit to the kingdom’s budget may be more than the rulers are prepared to accept for a prolonged period.
The price war spells bad news for the TSX. Energy stocks make up 23.2 per cent of the Composite Index so any downward movement will have a pronounced effect. So far this year (to Nov. 6) the S&P/TSX Capped Energy Index has lost 6.2 per cent, making it one of the main contributors to the Composite’s lacklustre performance. The only reason things haven’t been worse is that oil is priced in U.S. dollars so Canadian producers have gained from the exchange rate differential.