Saudi Arabia raises white flag in its own price war on oil rivals

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Saudi Arabia waged a two-year price war of attrition on its oil-producing rivals. By agreeing to return to a system of output quotas, the kingdom is signalling the war didn't pan out.

The Organization of Petroleum Exporting Countries, of which Saudi Arabia is the dominant member, shifted in 2014 to a stance of acquiring more market share at the expense of higher-cost competitors. Its weapon: ever-falling crude prices.

The cartel tried to give U.S. shale producers, Canadian oil sands developers and others the same treatment that Standard Oil boss John D. Rockefeller foisted on his U.S. rivals in the 19th century as he accumulated market power. He called it "a good sweating."

But it is not Saudi Arabia's rivals but its allies in OPEC, such as Venezuela and Nigeria, whose domestic finances are in shambles due to severe drops in oil revenue, that have suffered.

OPEC is to meet on Nov. 30 to hammer out individual production allocations after agreeing last month to reduce output by 600,000 to 1.1-million barrels a day from current record volumes, but there's no guarantee the deal won't break down by then.

Saudi Arabia has apparently come to terms with the fact that the price war failed in its main objective – wresting market share in key regions of the world where demand was on the rise.

China is Exhibit A. It has long been seen as a main target of any country looking to boost energy exports, including Canada. But the stats show imports into China from Saudi Arabia have actually fallen since late 2013 – to less than 15 per cent from more than 20 per cent, according to a report from RBC Dominion Securities. At the same time, imports from Russia have grown steadily, from roughly 10 per cent to nearly 15 per cent.

In fact, Russia, Angola and even Venezuela have boosted shipments to China by far larger volumes this year than last year.

Venezuela, despite its political and social strife, has increased exports to China through arrangements that involve the swap of loans for oil, said Michael Tran, New York-based analyst at RBC. Brazil has done similar deals, giving secure access to the market when rival suppliers must compete solely on price and volume.

The market-share story is similar in the United States, where Saudi supplies have fallen to less than 15 per cent of U.S. oil imports, from more than 20 per cent in late 2013, when crude prices were nearly twice what they are now.

The kingdom has sought to secure more market there through its own addition to refining capacity. State-owned Saudi Aramco agreed this year to take full ownership of a former joint-venture refinery in Port Arthur, Tex., and is reportedly on the hunt for a Houston-area plant.

One thing the price war accomplished was to force U.S. shale producers to slam the brakes on drilling in deposits such as the Bakken in North Dakota and Eagle Ford in Texas. The massive increase in supplies from those fields was a particular thorn in OPEC's side, and U.S. shale output has waned (though it took longer than many experts predicted).

Now though, moves to juice the price through production cuts could sow the seeds of a rebound in the United States, through a return of rigs to the field and a rush among companies to hedge output at much higher prices than the current spot market affords, Mr. Tran said.

The Saudi gamble is that the other, higher-cost producers will be much slower to get back to pre-2014 activity.

"I think what the Saudis are thinking is, 'Look – we tried to kill U.S. production once, and it didn't work. So we're making a calculated bet that if prices climb to a low- to mid-$50 (U.S.) environment, U.S. production will still come back, but the rest of the world is not going to be able to grow production meaningfully,'" he said.

Indeed, in Canada's case, oil sands-production gains are locked in for the next few years with projects that proceeded before the worst of the oil-price collapse.

The moves suggest that OPEC would be content with oil prices that edge up gradually, rather than spike back to levels that created this costly mess in the first place.