Saudi Arabia's Oil Agenda

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Includes: BNO, DBO, DNO, DTO, DWTI, OIL, OLEM, OLO, SCO, SZO, UCO, USL, USO, UWTI
by: Katusa Research
Summary

Here's a look at Saudi Arabia's OPEC policy on oil production.

I'll explain the dynamic environment of energy.

Using a sweet 1970s playlist to illustrate some important points.

What OPEC Doesn't Want You to Know

  • "Changes" - David Bowie
  • "Brick House" - The Commodores
  • "Black Magic Woman" - Fleetwood Mac/Santana
  • "Hotel California" - The Eagles
  • "Crazy" - ERA Flair

"Changes" - David Bowie

What do Saudi Arabia and David Bowie have in common? Both the country and the musician have been able to reflect on their present self and the changes around them. Bowie was going through several changes during the mid-1970s, especially those famous dietary changes which put cocaine, red peppers, and milk on his plate. David Bowie was famous for constantly looking to the future, changing his music, persona, and never relying on the nostalgia of the "good old days." Sure, Saudi Arabia may not share in Bowie's love for cocaine, but the second largest oil producer is attuned to the "changes" in the oil industry. Its policy pivot from stabilizing oil prices to letting the market run oil prices down in November 2014 stemmed from structural changes in market.

In the news, we often hear that Saudi Arabia has boosted production and cut its selling price of crude oil to hurt U.S. shale production, punish OPEC producers, and/or increase the toll sanctions are having on the Iranian economy. However, maybe Saudi Arabia has more in mind than using oil as a policing tool. Maybe the Saudi government has noticed a fundamental shift in the oil industry. For one thing, the U.S. shale revolution has changed the landscape of the oil market by giving more power to one of the largest consumers of energy in the world. For another, energy switching began to take place around the world as natural gas and renewable energy pricing remained competitive with oil prices.

The worry for oil investors shouldn't be the possibility that Saudi Arabia is lowering prices and increasing production to punish anyone, but that the Saudis are doing so to re-establish the oil market. If the Saudis are looking to increase global demand for oil, this low oil environment could be the new normal for years to come.

"Brick House" - The Commodores

The Commodores' 1977 single "Brick House" (or "BRICK House," if you will) offers a parallel to the historical strength in oil demand from the BRIC countries in the beginning of the 21st century. In 2005 the world experienced fast-paced growth driven by the developing nations of Brazil, Russia, India, and China (the BRICs). From 2005 oil prices exploded upwards by $44 per barrel to $100. Unlike the "mighty, mighty" lady referred to by the Commodores, this BRIC house was not as stable. After 7 years of growth the rising oil price had reduced the growth of oil demand from 3.9% in 2010 to less than 0.1% in 2014.

After years of sustained oil prices in the $100 range, the tables were turned and demand degradation had become the long term concern for oil exporting countries. Saudi Arabia noted that $100 oil gave rise to investment in alternative energy sources that are now reducing demand for its oil. The Saudis' response: lower the price of oil to re-invigorate oil demand and slow investment in alternative options. Establish oil as the low-cost energy source.

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"Black Magic Woman" - Fleetwood Mac/Santana

In the late 1960s, Fleetwood Mac released an underappreciated single called "Black Magic Woman." The song did not become a hit until the early '70s when one of the best guitarists to bless the earth, Santana, turned the song into a diverse set of altered chord patterns with the blended influence of rock, jazz, blues, and Latin flare. Santana's rendition captured the attention of audiences as varying sounds competed with each other in an orchestrated showdown.

The "new" energy industry is Santana's version of "Black Magic Woman," where new countries and new forms of energy are competing with each other for a share of the market. Although crude oil was one of the primary traditional sources of energy -- along with coal, natural gas and nuclear-renewable energy sources have been steadily gaining market share.

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This competition accelerated in 2005, as oil prices spiked and consumption of natural gas and renewables increased. In addition, investment in renewable energy followed the rise in oil prices due to a more accommodating competitive landscape for renewables at $100 oil.

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Saudi Arabia knew that renewable and gas projects were outcompeting oil at these prices and that forced them to push prices down to re-establish long term demand. The varying price competition is most starkly shown through the diverse energy landscape of the U.S. here domestic oil, natural gas, and renewable energy compete for market share in the new energy environment.

"Hotel California" - The Eagles

"You can check out any time you like, but you can never leave," is what Saudi Arabia hopes to establish with its low oil price policy. As Saudi sees oil demand picking up in China and the Asia Pacific, the new normal for oil prices could hit a ceiling of $60-$70 per barrel to extend demand growth for oil. In the meantime, to take advantage of the market, Saudi Arabia and its Gulf partners have diverted funds to establish a more diversified energy sector.

The United Arab Emirates (UAE) have pushed for further investment into solar and wind as they become cost competitive with natural gas. In January 2015, the UAE established the Mohammed bin Rashid Solar Park with the world's lowest solar energy cost of $0.06 per kilowatt or $93 per barrel equivalent. The UAE will also double crude oil refining capacity in Abu Dhabi to over 900,000 barrels per day (bbls/d) and start to replace crude oil exports with petroleum product exports.

Qatar, the world's largest exporter of condensate will start to export less raw condensate. Qatar has invested in splitter capacity that will split condensate hydrocarbons into shorter chains of lighter and more expensive low-sulfur diesel and naphtha. The country expects to complete the construction of its Ras Laffan condensate splitter by 2016 with 146,000 bbls/d of capacity.

Saudi Arabia has increased their refining capacity by 40% over the last decade. Between 2014 and 2018 Saudi expects to spend $60 billion on downstream operations which would increase refining capacity from 5.4 million bbls/d to between 8-10 million bbls/d. As the country moves vertically along the value chain from production to refining, Saudi will compete in the higher market value segments of refined products.

Finally, Saudi Arabia is aggressively recruiting laid-off shale workers from the US to explore and develop domestic unconventional gas fields on- and offshore. The goal is for shale gas to replace 900,000 bbls/d of oil used for domestic energy consumption and may eventually allow Saudi Arabia to export most, if not all, of the oil and petroleum products it produces. To date, Saudi Arabia has drilled 8 horizontal gas wells and plans to drill many more with the expertise of those US workers. Saudi Arabia has an obstacle, in that it will need to figure out the logistical issues with bringing fresh water to fracture shale wells. But the recruiting of shale experts is a significant step in the right direction.

"Crazy" - ERA Flair

Although this classic ERA Flair single wasn't produced in the '70s, it has a very special place in my heart, much like the resource sector. The ups and downs in the resource market can often make investors crazy, but I love this market. I have spent much of my life analyzing the world's mining, oil and gas dynamics, and I feel confident that I accurately understand the future of the industry. At the height of the oil market I warned investors to remain cautious and expect oil prices below $75 per barrel. Before the U.S. Thanksgiving holiday last year, I stressed that oil would fall further as it was clear to me that the Saudis would keep production strong and retreat from its price stabilizing policy. I believe that the Saudis will continue to press further on their "no cut" mentality at the June 5th meeting of the Organization of the Petroleum Exporting Countries (OPEC).

Once again I am making a bold statement by putting my financial resources behind the future of energy: renewables. Although there are opportunities in the resource market, I have found a renewable energy company backed by heavy hitters with deep pockets, a stable free cash flow for the next 16 years, a tremendous growth profile and a dividend that will be announced shortly. This investment is already in production, with a diverse set of renewable resources around the world.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.