Crude is tanking. Why then are the Saudis so confident?

March 16, 2020, 5:45 PM UTC

Saudi Aramco, the state-run oil giant, has laid bare its calculations for how it could win a ferocious oil price war, one mostly of its own making.

On Monday, it doubled down on its vow to defeat the twin forces of plunging oil demand and the coronavirus pandemic by pumping and selling more oil. A lot more.

It has a big advantage over much the rest of the oil-producing world in that it can still make money at today’s rock-bottom oil prices. And if it gluts the market with more, it’s still in the black. Analysts though aren’t so sure it’s that easy.

Still, company officials took them through the numbers on a webcast in which the company also discussed the company’s first annual results since its December IPO. It was a rare occasion to see inside one of the most powerful, but most secretive, players on the world energy markets.

Key to the company’s last-man-standing strategy is the conviction that a protracted crude price war will drive higher-cost producers, including many U.S. shale drillers, out of business.

The oil price has plummeted since Saudi Arabia failed earlier this month to persuade Russia to agree to deeper oil production cuts to bolster prices as coronavirus ravages global demand, grounding planes and shuttering factories. Brent fell below $30 a barrel Monday as new figures showed Chinese industrial output plunging at the start of this year.

That’s not a big deal though, says Khalid al-Dabbagh, Aramco’s chief financial officer, who maintains the company can profitably produce oil for just $2.80 per barrel.

“We are very comfortable with a $30 price in terms of our gearing. We are very comfortable we can meet our dividends commitment, and we are very comfortable we can meet our shareholder expectations at $30 and even lower,” he told analysts. “As production increases, our unit costs would significantly go down.”

Strained finances

Despite the fighting talk, a persistently low oil price would in fact slash the royalties Aramco pays to the Saudi government, putting intense pressure on the country’s already strained finances.

After talks with Russia broke down, Saudi Aramco announced last week that starting in April it would supply 12.3 million barrels per day of oil to its customers—that’s around 27% (300,000 barrels a day) above current levels, and above the company’s current maximum sustained oil capacity.

Saudi Aramco chief executive Amin Nasser added that it will dip into its supply stock to hit that figure, and that it’s in it for the long haul, beyond April.

“The decision for April is 12.3 (million bpd), and I doubt if May will be any different but we will evaluate it,” he said.

Nasser said Aramco could sustain maximum production capacity of 12 million bpd for a year without the need for additional capital spending. “After that it can be sustained indefinitely if required,” he said.

Ripple effects

Since the so-called OPEC+ agreement broke down, the United Arab Emirates has said it will increase production and Moscow has said it could do so, raising the prospect that the world could be flooded with cheap oil at a time when demand is feeble.

Analysts warn the strategy could easily backfire as the global economy limps along from the effects of coronavirus.

“The potential loss of demand in March-April may dwarf anything the world has ever seen, just when OPEC+ producers open the floodgates of new supply to the market,” said Bjoernar Tonhaugen, head of oil markets at research firm Rystad Energy.

The Saudis showed their resolve over the weekend when they provisionally hired 25-30 giant carriers to load later this month or early next, according to Paola Rodriguez-Masiu, Rystad Energy’s senior oil analyst.

“As the COVID19 proves more resilient than anticipated, and Saudi Arabia and Russia continue to be engaged in a market-share war, we find that the oil price could fall even into the $20 territory to trigger production shutdowns, as the level of global stock building that we currently see is not sustainable,” she said in a note.

Saudi Aramco, the world’s most profitable company, was already seeing fierce headwinds to its business even before the pandemic outbreak. On Sunday, the company said its net income fell by 20% in 2019 to $88.2 billion, mainly due to lower crude oil prices and production volumes. It said it would cut capital spending to $25-$30 billion in 2020, “in light of current market conditions,” from $32.8 billion last year.

Saudi Aramco’s shares fell another 3% Monday to 27.80 riyals, 13% below the price it floated at in December.

While Saudi institutional and retail investors bought heavily into the IPO, many Western investors shunned the offer, believing it to be over-priced. At current market prices, the company is valued at $1.5 trillion, down from the peak of more than $2 trillion it hit within days of listing.

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