Is Saudi Arabia Using A Rope-A-Dope Strategy?

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Includes: DRIP, GUSH, IEO, NDP, OIL, PXE, USO, XOP
by: Robert Boslego

Summary

Saudi Arabia stated it wanted to regain market share from U.S. oil shale.

It flooded the market, crushing prices.

It is suffering a massive budget deficit.

But oil shale companies may have to liquidate assets.

Is this a rope-a-dope strategy?

Muhammed Ali v. George Foreman: The Rumble in the Jungle, 1974.

Rope-a-Dope

The idea was to lean on the ropes "like a dope" taking punishment until his opponent "punched himself out." The ropes provided the elasticity to take the blows rather than the body. Then Ali exploited Foreman in a counterattack and finished him off.

In situations beyond boxing, rope-a-dope describes a strategy in which one party purposefully puts itself in what appears to be a losing situation, but weakens an opponent and then becomes the victor.

The Saudi Gambit

There has been a lot of speculation about Saudi Arabia's decision to flood the oil market. The stated rationale was to re-gain the market share it was losing from shale oil. Saudi Arabia appeared to have increased its output to capacity last spring, producing another million barrels of oil.

The impact on prices has been severe. The net loss of revenues caused the Kingdom a budget deficit of $150 billion. I have thought its decision to flood the oil market was a $500 billion dollar blunder. The reason the oil industry did not expect such a move was that it made no financial sense in the short-term, at least.

Others think the motivation is political in nature. That it's meant to weaken Russia and Iran because they suffer more than Saudi Arabia.

Discussion has turned to thoughts about Saudi Arabia's end game. How do shale oil producers survive losing money? How do oil producing countries survive running massive budget deficits?

From the shale oil side, it is clear that the oil isn't going anywhere. Companies may go bankrupt and have to liquidate assets. New buyers acquire their properties at "bargain basement" costs, enabling them produce them with a lower cost basis in the future.

Oil producing governments have the unappealing but stopgap measure of devaluing their currencies. That hurts their citizens' purchasing power for foreign goods but enables the country to continue to pay its workers in the oil industry to keep pumping.

How does Saudi win this stand-off?

John D. Rockefeller

Saudi Arabia may be attempting to emulate the strategy of none other than John D. Rockefeller. His Standard Oil Company's most potent weapon against competitors was underselling and then acquiring his weakened targets. By the 1880s, it owned 90 percent of world oil refining capacity. Rockefeller amassed a fortune estimated to be $336 billion in totals dollars.

Motiva

Motiva Enterprises, LLC, is a 50-50 joint venture between Shell Oil Company [the wholly owned American subsidiary of Royal Dutch Shell) (NYSE:RDS.A) (NYSE:RDS.B)] and Saudi Refining (controlled by Saudi Aramco). The company is currently headquartered in Houston, Texas, United States.

Motiva Enterprises owns and operates three oil refineries in the gulf coast region of the United States: a 600,000 bbl/d (95,000 m3/d) refinery in Port Arthur, Texas, a 235,000 bbl/d (37,400 m3/d) refinery in Convent, Louisiana, and a 240,000 bbl/d (38,000 m3/d) refinery in Norco, Louisiana. On May 25th, 2012, Motiva officially completed its expansion of the Port Arthur refinery to a capacity of 600,000 bbl/d (95,000 m3/d) making it the largest refinery in North America and the fifth largest in the world.

Saudi already has a stake in the U.S. refining industry. Is it possible that it intends to use it to purchase a share of U.S. oil assets in liquidation sales, thereby regaining its lost market share as a result of low oil prices this year?

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.