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Saudi America’ effect unlikely to dent oil prices

“Saudi America”, they are calling it: the boom in US oil production that on some forecasts will make the country a net exporter of crude by the end of the decade.
It is an exciting prospect, promising dramatic growth for the companies able to capitalise on it. Enthusiasts for America’s oil surge often make grandiose claims about the future on the basis of what is still only a very limited history, and there are many risks to that rosy outlook, from environmental protests to doubts over the accuracy of estimates for shale reserves.
Yet there is one widely discussed possibility – a sustained fall in oil prices – that may be less of a threat to the US industry than is often feared.
Consumers’ hopes of lower oil prices have been raised by the fact that after a long decline from its peak in 1971 to a trough in 2008, US crude production has risen about 1.5m barrels per day to about 6.5m b/d in September. Forecasts that by 2017 the US will overtake Saudi Arabia to become the world’s largest oil producer, including natural gas liquids such as ethane – as the International Energy Agency has predicted – require rapid growth over the past four years to be continued beyond the next four.
There are several reasons why this progress might be derailed. Oil companies may have been over-optimistic about the long-term potential of the US shale reservoirs that are the source of the new production, or there could be a political backlash against hydraulic fracturing, one of the techniques that makes it possible to develop those reserves on commercially attractive terms.
Another risk cited by analysts, including the IEA, is that there could be a sustained fall in the price of oil to below the levels needed to make US shale oil production viable. As with shale gas, the shale oil boom has been led by smaller and midsized producers, rather than the giant international oil companies. IOCs including ExxonMobil, Chevron and Royal Dutch Shell are now moving into shale oilfields, but the most active companies in the Bakken shale of North Dakota, the heart of the boom, are groups such as Continental Resources, Hess and Whiting Petroleum. Lacking the deep pockets of the IOCs, and already squeezed by weak prices for gas and NGLs, they would be forced to cut back on investment if their cash flows came under pressure.
US shale oil producers are also vulnerable because their costs are so high. Needing break-even prices in a range of $44-$68 per barrel, according to the Rystad Energy consultancy, they are not the world’s most expensive sources of oil. That dubious honour probably goes to new mining projects in Canada’s oil sands, or in the deep waters off the coast of Brazil.
Nonetheless, North American production costs are significantly higher than in many parts of the Middle East. That means the important question for the future of the US as “the new Saudi Arabia” is what the old Saudi Arabia makes of it. Opec has made it clear it is watching the US oil boom with apprehension, and rightly so: it is the greatest threat to the cartel’s power since the fields of Alaska and the North Sea were opened up in the 1970s.
As US production grows, Opec countries will be forced either to restrict expected growth in their output – whether by slowing investment in new capacity or holding increased unused capacity – or accept a much lower oil price. As the only Opec member with both significant spare capacity and the capability to invest in capacity additions, Saudi Arabia holds a pivotal role. If it stepped up production and drove down the oil price, it could devastate the US shale industry.
Bernstein Research calculated in September that $60 oil would cut North American exploration and production companies’ capital spending by 40 per cent, which would “lead to a collapse in drilling and workover activity across the US and Canada”. There are precedents for such behaviour, such as the 1997 Opec meeting at which Saudi Arabia agreed a large increase in production as the world economy was slowing, pushing the oil price to $10.
The difference now is that, shaken by the upheavals that have swept through the Middle East and north Africa, Saudi Arabia has been raising public spending sharply. The Institute of International Finance has estimated that by 2015 the kingdom will need an oil price of $110 to balance its budget. Saudi officials have disputed that calculation, but $60 oil would be no more welcome in Riyadh than in Williston, North Dakota.
With Saudi Arabia and Saudi America both in agreement, the threat – or for consumers, the promise – of significantly lower oil prices is unlikely to be fulfilled.

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