Inside Shell’s earnings report: Proof that the Saudis’ oil market strategy is working
By Puneet KolliparaJanuary 29 at 5:43 PM
Saudi Arabia shocked the world last fall in breaking from its traditional mold of keeping oil production artificially low to prop up oil prices. Instead, the Saudis and other OPEC nations voted to keep oil output steady even in the face of a global supply surplus, a move seemingly designed to respond to the threat that the Saudis see from rising output from non-OPEC producers — from U.S. shale plays to Russia’s Arctic to Brazil’s deep offshore waters.
The idea behind the Saudis’ gambit was simple — to avoid ceding their market share while observing how low North American and other producers would go before the price of oil was no longer right for them to keep pursuing higher-cost projects.
If the latest earnings and outlook announcements by oil giants like Royal Dutch Shell are any indication, the Saudis’ strategy is starting to work. The oil giant announced fourth-quarter profits of $4 billion (double what they were at the same time the previous year, but still less than analysts had expected). But the company also said that it would actually have to delay or outright cancel $15 billion in spending on 40 projects over the next three years. Among the changes in plans are delays in two phases of its Carmon Creek project in Canada’s oil sands, as well as a slowdown in new deepwater drilling.
Shell is far from unique. It’s just one of a host of other companies that have scaled back their near-term spending plans, as this chart of oil companies’ capital budgets for 2015 shows. Virtually all companies are cutting back to some extent — decisions that analysts say are driven by the global surplus of supply.
“Saudi Arabia signaled that it is abdicating its role as the swing producer in the global oil market, and it’s instead going to be very hard-line about protecting its own market share,” said Pavel Molchanov, an analyst at Raymond James & Associates. “These austerity measures across the global oil industry are what needs to happen to rebalance the market.”
Molchanov suggested that in the near term companies generally are shelving projects such as onshore oil drilling that are easy to shut down and then re-ramp up in spur-of-the-moment responses to oil price changes. More-ambitious, decade-or-longer-scale projects such as deepwater drilling or oil sands mining are tougher to postpone once they’re already underway, but some of these projects that haven’t gotten underway may get significantly delayed or canceled entirely if the long-term oil price outlook grows dimmer.
It’s unclear how long companies will keep cutting back. Since the market is tight — the oil supply surplus is a tiny fraction of all the oil on the market — any sort of uptick in demand or supply disruption could have an outsized impact and bring everything back into tighter balance. That could explain why Shell insists it’s not over-reacting to lower oil prices.
“It is very important not to get into a ‘slash and burn’ mentality, but I want to have a very measured approach,” CEO Ben van Beurden said in an earnings call with reporters.
But the Saudis are hoping that lower prices brought on by the supply surplus will eventually have a broader impact on the U.S. shale boom and discourage relatively high-cost investments in the Russian Arctic, the Canadian oil sands and Brazil’s deep offshore waters. While those latter three are long-term projects that rely on long-term oil prices, companies still tend to pay a lot of attention to what’s happening now. And Saudi Arabia can afford to wait. Even though prices have tumbled, Saudi Arabia has a large treasure chest of savings from past years and some of the world’s lowest production costs.
To be sure, Shell isn’t cutting back across the board. For instance, Shell still wants to explore for oil and natural gas in Arctic waters off the Alaskan coast, and the company hopes that U.S. regulators will sign off on the needed permits in 2015. To some extent, this isn’t a surprise: Even though a combination of administrative delays and legal wrangling in recent years has repeatedly delayed the company’s plans, Shell has already invested about $6 billion toward its Arctic ambitions. The company clearly sees the Arctic as a valuable potential addition to its proven reserves.
But the lesson here is simple. The Saudis’ paradigm-changing strategy is having an impact in the here and now. What’s still unclear is what that means in the long term.
The TRUTH will set you FREE.
Potentially, a prolonged period of low oil prices might finally see BP and Shell, like two drunken sailors, holding each other up through the merger that has so long been on the horizon.
