Saudi Arabia delivered the most powerful signal yet that oil prices are not poised to rebound any time soon by abandoning its passive response to the world oil glut.
Instead of leaving its own production flat, it is boosting output in an apparent attempt to claw back market share in a hurry. On Tuesday, Saudi Petroleum and Mineral Resources Minister Ali al-Naimi revealed that the kingdom's oil production in March was 10.3 million barrels a day – a record high.
"Saudi Arabia is going for it," Olivier Jakob of the Swiss energy consultancy PetroMatrix said.
The rise in Saudi production and reports on Wednesday that U.S. crude inventories had posted their biggest weekly gain since 2001 reversed the oil rally. Brent crude, the effective international benchmark, fell 4.5 per cent to $56.45 (U.S.) a barrel. West Texas intermediate lost almost 6 per cent, taking the price to less than $51.
The Saudis' strategy switch came as the 50-per-cent drop in prices since June triggered the biggest oil-and-gas merger in a decade. Royal Dutch Shell PLC, the Anglo-Dutch energy giant, announced Wednesday morning that it is buying Britain's BG Group PLC (formerly British Gas) for £47.7-billion ($87.7-billion Canadian) in a cash-and-shares deal.
The blockbuster deal was driven by both companies' desire to cut costs as oil prices fall and Shell's aim to build reserves quickly by buying them on the stock market instead of drilling for them. Shell was especially attracted to BG's liquefied natural gas developments.
Saudi Arabia's aggressive new production strategy came as a surprise. At the key Organization of Petroleum Exporting Countries meeting in November in Vienna, the Saudis left production levels intact instead of tightening them to prop up prices, as they had done when prices had fallen sharply in the past. That decision was enough to send prices plummeting. Since then, many oil investors, consultants and executives had pretty much assumed that the Saudis' passive stance would endure. They were wrong.
Two weeks ago, Mr. al-Naimi announced that Saudi crude production in March would be about 10 million barrels a day, which is about 400,000 barrels more than the November figure. On Tuesday, he revealed that March production landed at 10.3 million barrels a day, an increase of almost 700,000 barrels from February. Mr. Jakob says the March figure marks the biggest monthly production increase since November, 2011.
Mr. al-Naimi said Saudi Arabia will continue to produce about 10 million barrels a day. The true figure could be higher.
Why is Saudi Arabia opening the spigot? There is no doubt that country's own domestic demand is rising, thanks to heavy investment in new refineries, requiring more production. But it also appears that Saudi Arabia is making a renewed push for market share for fear that a gusher of Iranian oil will soon hit the export markets as the Iranian embargo is ratcheted back. "They will not want to abandon any market share to Iran," Mr. Jakob said.
The problem for oil producers and investors is that the Saudis are not acting in isolation. In March, both Iraq and Libya managed to boost production in spite of the violence and chaos in those countries. As a result, OPEC production in March was about 31.5 million barrels a day, an increase of 1.2 million from February and two million from March, 2014. The March figure is well above the second-quarter estimate put out by the International Energy Agency.
At the same time, U.S. production is surging, creating burgeoning stockpiles of oil. On Wednesday, the weekly status report from the U.S. Energy Information Administration showed that American crude stockpiles climbed by 10.9 million barrels to 482.4 million for the week to April 3. The rise was three times greater than forecast.
The combination of rising U.S. and Saudi production can only be bearish for oil prices. The prospect of oil testing its January low should not be ruled out, especially if Iran is given the green light to ramp up exports.