Cheap Oil: Saudis sought surplus profits, but were trapped in their own snare

Petrol and diesel prices have not shrunk as dramatically as oil price. Refineries and chains of gasoline filling stations now earn trice as much as they did a year ago. This sparked a scandal in Great Britain. FairFuelUK accuses refineries and owners of filling stations of fixing up. Howard Cox, the founder of FairFuelUK Campaign, says drivers overpay five pounds to gas stations in average. In his words, the traditional margin at gasoline filling stations was three pennies per liter. The margin rose to 9 pennies within the year. Actually, 37 million British drivers overpay 185 million pounds ($266 million) for one filling operation. 

FairFuelUK data are confirmed by data of ExxonMobil. For nine months of 2015 alone, its proceeds from oil recovery fell by 71% and from refining and sale of finished products doubled. It is noteworthy that Saudi Arabia reckoned with surplus profits of “downstream” when unleashing the oil war against U.S. for the share in the market. During the last years, Riyadh waged a calm but large-scale expansion into the global market of oil refining. At present, the key state oil company Saudi Aramco holds shares in refineries in U.S., China, and South Korea. It has built three mega-refineries during the last two years in the country. Saudi Aramco sends more than 20% of the recovered oil – more than 2 million barrels a day – to the existing capacities.

Yet a year ago, analysts of Barclays Capital Bank said Saudi Arabia is changing its strategy in the oil business to recompense the shrinking oil price with sale of finished and more expensive products. In addition, specialists say it will help linking larger volumes of oil recovery to specific processing capacities. The main focus is Asia. Saudis plan to build one more mega-refinery in Vietnam.

Nevertheless, surplus profits from refining do not save the Saudi sheikhs. Riyadh unleashed a price war for oil to keep its share in the market and deal a major blow to the U.S. shale oil. Yet, it miscalculated about the terms and about how low the oil price might fall. Saudi Arabia anticipated that everything should be easy like it was during the oil crisis of 1980. They would increase recovery, the price would fall, and the high cost value of the shale oil would make its recovery unprofitable. Eventually, the myth about American miracle would whip up burying hundreds of recovery companies, oil prices would increase again, and Saudi Arabia will be home free. In fact, the things happened a little differently. The process proved longer than they expected. As compared to 1980s, the situation on the global oil market has changed dramatically. Saudi Arabia miscalculated about many factors.

At present, half of the companies engaged in shale oil recovery in U.S. are either on the verge or at the stage of bankruptcy. However, they are not going to give away and are borrowing long-term loans and making insurance contracts. By data of EIA (Energy Information Administration of U.S.), by February, recovery of shale oil will shrink by almost one million barrels a day year on year. This is only 20% of the current recovery. Therefore, the American miracle is not going to collapse yet. However, Saudi Arabia is not going to stop the oil war either. A defeat would mean that Riyadh will lose its status and positions as a geopolitical actor. 

Many analysts say the Kingdom not just looks to hamper recovery of shale oil, it seeks to put investors off investing in refining anywhere in the world. However, Riyadh did not expect that the companies engaged in recovery of shale oil will be so enduring. It lost control over prices too. The prices shrank so that the largest oil exporter found itself at a crossroads.

At present, many analysts forecast that oil prices will stay at $30 per barrel +/- $10.  Saudi Arabia would surely like to see oil price higher but it would require reduction of oil production. However, they will never agree to lose their share in the market. Other oil producer countries are not going to reduce production either. Oil supply exceeds demand now, amid pessimistic economic development forecasts for China – the major consumer of the “black gold.” In addition, sanctions against Iran are likely to be rescinded. In this light, Iran promises to supply several millions of barrels of oil daily to the market. All these factors will hardly lead to an increase in the oil price, though many countries and companies are dissatisfied with it. It will remain low for unknown period of time.

Western analytics companies say Saudi Arabia’s reserve power will be enough for a year or two. The country cannot reduce the high social commitments inside the country or stop military campaigns in the Middle East. Therefore, the country’s budget remains almost the same as it was when oil cost $100 per barrel. In 2015 alone, Saudi Arabia had to use $100 billion from its $600 billion reserves to cover the budget deficit. Yet, this appears to be insufficient.

Last week, Mohammad bin Salman, deputy crown prince of Saudi Arabia, told The Economist that Riyadh plans to sell part of Saudi Aramco. It is the largest company in the world and will be estimated at more than one trillion dollars if entering stock exchange.  A source of Reuters says Riyadh seeks to sell some shares in its refining subsidiaries, not the company itself or oil recovery – the cornerstone of its success and instrument of its geopolitical games. Amid shrinking oil price, these subsidiaries bring surplus profits which appear to be insufficient to bring the Arab monarchy out of its own snare.

EADaily analysis