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Saudi Arabia, Unintended Consequences Or Best Frenemies?


The Price of oil has collapsed due to their attempt at "increasing market share".

China has come in strong, buying up oil like it's on sale.

They end up increasing prices everywhere....Other than the US. Which is great for the US consumer, but bad for shale.

Saudi Arabia is perhaps one of the US's oldest friends, and so the cynical among us would like to see their recent suppression of oil as a move against Russia; on the face, this would certainly make sense as a plunging oil price would severely affect the oil-dependent Russian economy.

On the other side of this trade, however, waits China. It stands as the greatest beneficiary from low oil prices, and has been buying a great deal of it. In fact, China is the largest single purchaser of oil in the world. In this light one might ask if the suppression of oil were really only for the "benefit" of the US.... I'll get back to that later.

To complicate matters further, cheap oil is not a purely beneficial arrangement for the US. It certainly allows the average person to spend less at the pump, and for this reason would boost the US economy by allowing him to consume more of other things (consumption being the primary driver of GDP growth in the US).

On the other hand, the shale oil industry is notorious for its high costs per barrel.... In fact, with costs ranging from $50-$100, some production will be curtailed now that prices have gone below $80. Cheap oil benefits China in both manufacturing AND increased consumer activity.

Finally, one has to consider the state of the so-called recovery in the Western developed countries; with low demand for oil, this would tend to suppress oil prices further even without Saudi Arabian intervention. Perhaps Saudi Arabia is merely reacting to reduced demand.

Three scenarios present themselves if we consider the above factors; first, that Saudi Arabia had pushed prices down to help their US allies spite Russia, and unfortunately because China is buying so much of their oil, they have no choice but to raise prices slightly in Asia and Europe. However, that begs the question of why they continued to reduce prices in the US.

Second, it was reacting to overall reduced demand by aggressively clawing for market share. A canary in the coal mine to some extent.

Most likely, this move was aggressive rather than friendly, and was aimed directly at the US shale industry. Nip a potential rival in the bud, perhaps, and after investors had already sunk a great deal of capital into the industry.

Such a move has far wider implications than mere market share expansion, it suggests that Saudi Arabia is distancing itself from the US and does not depend quite so heavily on US support. The petrodollar itself becomes less of a certainty in coming years.

In conclusion, I believe that if prices continue to stay below 80USD or fall much further, oil companies and particularly fracking companies will be facing more pain. Exposure to oil and fracking equity will thus be unwise in the short-run. Russia will also be hard hit, although the question is if the recent sell-off of Russian equity and the Ruble has been over-done at this point. In the long-run, this might have particularly troubling implications for the US. This is because a large advantage that the US has is its reserve currency status, itself closely linked to the petrodollar. Is one of its closest allies considering backing the new largest purchaser of oil? I would like to know what our readers think, feel free to leave a comment below.

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 (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.