OPEC "Effectively Dissolved" - Saudi Arabia May Go Broke Before US Oil Industry Backs Down

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When Saudi Arabia stopped supporting oil prices last November, many thought that they could use their large national reserves to undercut the competition and force U.S. shale producers out of business. As oil prices fell, they seemed confident they could ride it out and maintain their historically-dominant market position. 

Back in December, The Economist argued that absent a major unforeseen event, America's shale industry should be able to genuinely rival Saudi Arabia as the world's marginal producer. They were right.

It now appears that Saudi Arabia's confidence was misplaced and such a strategy was, in fact, misguided. This all puts the newly-coronated King Salman in a tough position, to say the least.

Bank of America says OPEC is now "effectively dissolved". 

"It is becoming apparent that non-OPEC producers are not as responsive to low oil prices as had been thought, at least in the short-run," admits the Central Bank of Saudi Arabia in its latest stability report. "The main impact has been to cut back on developmental drilling of new oil wells, rather than slowing the flow of oil from existing wells."

While low prices have scrapped plans for a variety of high-cost and high-risk ocean investments, something environmentalists around the world can be pleased about, US shale producers are not that high-cost, and experts from IHS think companies could reduce costs another 45 percent this year.

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The IHS experts believe these efficiency gains are possible not only through switching production to just the highest-yielding wells. Continually advancing drilling technology allows operators to launch 5 - 10 wells in different directions from one site. Other cost saving techniques are about to be implemented as well. 

"We've driven down drilling costs by 50 per cent, and we can see another 30 per cent ahead," said John Hess, head of the Hess Corporation.

While the North American rig-count has dropped down to 664 from a high of 1608 in October, output  has still risen to a 43-year high: 9.6million barrels per day. Experts believe it is only just beginning too. Rex Tillerson, head of Exxon Mobil, recently said "The freight train of North American tight oil has kept on coming."

While the oil industries in Colorado and elsewhere have felt the challenging effects of such a shakeout, America's oil & gas industry is now more resilient and efficiency keeps improving. This is good news for consumers. Lower prices with lower volatility should boost demand, resulting in additional growth. Economists calculate that the price cut has shifted well above $1.3 trillion from producers to consumers. 

Advances in renewable energy technology will increasingly offer people the choice of using a substitute, further limiting oil's power in the future.

"Prices are not going to snap back. People are in denial," said Prince Nawaf Al-Sabah, head of Kuwait's explorer, KUFPEC.

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This is troubling for countries that relied too heavily on one industry for their national income. Saudi Arabia, for example, relies on oil for 90% of its national budget. The International Monetary Fund estimates that this year's budget deficit will reach 20 per cent of GDP , or roughly $140 billion USD. The 'fiscal break-even price' is $US106.

While King Salman does face economic uncertainty, it's becoming more certain things are not going his way. He faces greater uncertainty politically-speaking. Can he maintain social stability within his country? Within the Middle Eastern region? Read more about the economics and possible political implications in an article by Ambrose Evans-Pritchard here.