Saudi Arabia’s low extraction costs averaging around $3 per barrel gives the Kingdom an advantage over Russia and other oil producers in a price war, according to new research from MUFG Bank.
Talks between the Organization of Petroleum Exporting Countries (OPEC) and Russia fell apart on Friday when Russia refused to agree to a further 1.5 million barrel per day oil production cut. Crude oil futures plummeted Monday in the biggest one-day price drop since 1991. Saudi Arabia and the UAE have both announced plans to increase oil production beyond current capacity, fanning fears of a price war in the oil market.
“The marginal price of oil will be determined by producers possessing the most competitive extraction and fiscal as well as social costs – this augurs in Saudi’s favor at extraction costs averaging ~$3 per barrel compared with ~$30 per barrel for Russia,” the report said.
The announcement that Saudi Aramco would boost its production to 12.3 million barrels per day (bpd), up around 2.5 million bpd from March, increase its maximum sustained capacity to 13 million bpd, and aggressively discount its prices, are aimed at bringing Russia back to the negotiating table, the report said.
“There is little doubt that Saudi Arabia wants to revive OPEC+, which appears to be hanging by a thread. The Kingdom appears hopeful that the ease with which it can gain market share and sink prices will convince Russia to come back to the table and revisit a producer strategy,” the report added.
Russia’s motivation for breaking with the three-year OPEC+ arrangement, however, was likely aimed at US shale oil producers. Shale oil has come to dominate markets in recent years – the US is currently the biggest exporter of crude in the world. However, shale oil firms are highly leveraged, and have high breakeven figures as a result to service debt.
State or state-backed oil firms meanwhile have the luxury of falling back on large fiscal reserves to continue production. As such, while state producers can continue to pump oil all the way down to the cost of extraction, $3 for the Kingdom, $30 for Russia, US shale oil firms need a significantly higher oil barrel price.
Estimates from MUFG place the price needed for shale oil at between $43 to $55 per barrel.
“Russia’s decision to pull out of the OPEC+ agreement triggered the price collapse, and was squarely targeted at the shale sector given its current financial distress,” the report said.
While Russia may have pulled out of the OPEC+ agreement to target US shale oil producers, analysts have also framed the conflict as between Russia and Saudi Arabia. In this context, MUFG believes that both sides have enough financial capacity “to sustain the oil price war for many quarters, not months.”