Saudi Arabia dishes out ‘harsh’ economics lesson to U.S. oil producers

HOUSTON — Saudi Arabian Oil Minister Ali Al-Naimi wants to teach oil producers struggling to stay afloat with $30 oil a simple lesson in economics.

“Let me say to Americans, we have not declared war on shale, or on production from any given company or country,” Al-Naimi said Tuesday at IHS CERAWeek, a gathering of about 2,800 energy professionals and international leaders from around the globe in Houston.

Saudi Arabia, which has refused to cut its production to help buoy plummeting prices, instead is letting market forces pick the winners and losers, he said.

“The producers of these high-cost barrels must find a way to lower their cost, borrow cash or liquidate. It sounds harsh, and unfortunately it is,” said Al-Naimi, who’s one of the most influential oil executives in the world. “It is the more efficient way to rebalance market.”

It’s also becoming one of the most expensive games of chicken in history.

But who’ll blink first and how fast in this era of low prices and too much supply — the U.S. shale producers or OPEC countries?

So far, it’s been the U.S., where private companies have been slashing jobs and curtailing investment in their oil fields. The IEA expects the U.S. to reduce shale output by 600,000 barrels a day this year, and another 200,000 barrels per day next year.

Al-Naimi said Saudi Arabia isn’t trying to kill U.S. shale production. But it also won’t help the industry by cutting its own production, a move that would bolster prices and help ailing energy companies across the globe.

“I welcome new additional supplies, including shale oil,” Al-Naimi said.

The price of U.S. oil futures contracts fell 4.6 percent for the day to $31.87 per barrel following his remarks Tuesday.

Crude has crashed from a high of $107 in June 2014, and while consumers enjoy the lowest gasoline prices in years, the oil industry struggles with its worst downturn since the 1980s.

Scores of companies have cut tens of thousands of jobs and lost billions of dollars over the past 18 months. Dozens of smaller drillers have filed for bankruptcy protection, and as many as 74 North American producers face significant difficulties paying the bills, Moody’s Investors service said in a recent report.

“The theme is sort of depression and struggle,” said Raoul LeBlanc, vice president of North America upstream and finance at IHS.

The pain has been real and felt all around the world.

Some of OPEC’s 12 member countries and other large oil-producing nations such as Russia are facing brutal recessions because of low oil prices. But they can’t stop pumping.

Those countries rely on oil sales to fund national spending, even as those budgets shrink, and have to sell their crude at any price.

Even Saudi Arabia is considering selling shares in its national oil company, Aramco, the world’s most valuable firm, to bolster reserves that have been depleted by the market rout.

Shale oil, which was virtually nonexistent before 2009, has disrupted the broader market and revived an industry once assumed to be on a decades-long death march in the U.S.

The marriage of horizontal drilling with hydraulic fracturing set off of a shale boom in the U.S. over the past few years.

Fracking pumps a mix of water and chemicals at high pressures through the shale rock to break through layers of sediment where the oil and gas is trapped. Sand then is added to the fluid in increasing amounts to hold open the fissures, letting oil and gas flow up the well to the surface.

Companies first used the technique to find new sources of natural gas around Fort Worth and in Pennsylvania, but around 2009, figured out oil could be tapped as well.

Since then, the U.S. added 5 million additional barrels of oil per day to the market.

Nearly all of it is pumped from three shale fields: the Bakken in North Dakota, the Eagle Ford in South Texas and the Permian Basin in West Texas and eastern New Mexico — reaching daily production of more than 9.3 million barrels in November, which approaches the U.S. peak production of the early 1970s.

U.S. shale producers accounted for about 5 percent of the world’s 95.6 million barrels of oil produced in 2015, the U.S. Energy Information Administration reported.

“That’s how you upend an order,” said Jim Burkhard, chief researcher at IHS.

In the past, Saudi Arabia has cut or added supply to move world oil prices up or down. It’s currently producing more than 10 million barrels per day.

Even if one OPEC country cuts production, another OPEC nation — or U.S. shale producers — could step in to fill the void and take market share. That would also keep prices low.

The Paris-based International Energy Agency said it now expects shale to act as a de facto regulator on the market, with U.S. producers rushing drilling rigs back into fields such as the Eagle Ford, Permian Basin and Bakken starting when prices rise to around $60 per barrel. In theory, that would keep oil prices from soaring too high for too long.

“The price will be capped by U.S. shale,” said Fatih Birol, executive director of the IEA. “This is new.”

OPEC Secretary-General Abdalla Salem El-Badri said his group has been watching shale for many years, and believes that any improvement in oil prices only will encourage shale producers to drill even more.

“Any increase, the shale oil will come immediately,” El-Badri said.

But shale producers at CERAWeek weren’t as certain about the swiftness with which a production increase could happen in the U.S.

John Hess of Hess Corp., a major producer in the Bakken, said Wall Street isn’t opening its purse strings for shale companies any longer, so there’s no way to pay for that production increase to happen fast.

“The oil industry is experiencing the financial crisis that the financial services businesses felt in 2009,” Hess said.

That’s because almost no one wants to buy the companies’ debt, and those who do want significantly higher yields.

Junk-rated oil producers are having to pay investors more than 20 percent on their bonds, the highest yields in at least 20 years, the Bank of America reports. High-yield debt was a major source of money funding the shale boom, he said.

“The high-yield market basically dried up,” Hess said. “If the debt markets are closed, that’s going to cap shale’s growth in and of itself.”

Moody’s and Standard & Poor’s have been cutting the credit ratings of energy firms, which makes it more expensive for them to borrow money.

Even giant ExxonMobil isn’t immune. Standard & Poor’s said the company may lose its long-term credit rating of AAA — the highest credit rating for corporate debt.

OPEC members Saudi Arabia, Quatar and Venezuela, along with Russia, last week agreed to “freeze” production at January levels if other nations would do the same.

“It is not like cutting production,” Al-Naimi said. “That is not going to happen.”

There’s doubt that a freeze will stick.

Now that Iran is free from U.S. sanctions, the country plans to boost its own oil production to export to the U.S. The IEA expects Iran to add 1 million barrels per day to world supply over the next four years. U.S. companies are cutting budgets knowing more oil is coming.

ConocoPhillips Chairman and CEO Ryan Lance said the company isn’t counting on an oil price recovery this year.

“We at ConocoPhillips are planning for a worst case,” Lance said. “I don’t think you can plan on a freeze working.”

Mark Papa of Riverstone Holdings, the former CEO of shale pioneer EOG Resources, said he gives the OPEC-Russia agreement a “one out of 100 chance” of working.

“I think the system just balances out,” Papa said.

In the meantime, Papa expects a fundamental restructuring of U.S. oil companies, including lots of bankruptcies.