OPEC Price War Signaled by Saudi Move Risks Deeper Drop

By Grant Smith and Dan Murtaugh  

Crude oil is poised to extend the biggest slump in more than two years after Saudi Arabia signaled it’s ready for a price war with other OPEC members, according to Commerzbank AG and Citigroup Inc.
Saudi Aramco, the state-run oil producer of the world’s biggest exporter, cut prices on Oct. 1 for all its exports, reducing those for Asia to the lowest level since 2008. The move suggests that the biggest member of the Organization of Petroleum Exporting Countries is prepared to let prices fall rather than cede market share by paring output to clear a supply surplus, according to Commerzbank.
“There is no indication whatsoever that
the Saudis are going to put a floor into this market,” Seth Kleinman, head of European energy research at Citigroup in London, said by e-mail. “Saudi market share in Asia is really under assault. It is a price war. The Saudis will win, but it won’t be painless.”
Saudi Arabia has acted in the past to stop a plunge in prices. It made the biggest contribution to OPEC’s production cuts of almost 5 million barrels a day in 2008 and 2009 as demand contracted amid the financial crisis. The kingdom would need to reduce output about 500,000 barrels a day to eliminate the supply glut now stemming from the highest U.S. output in three decades, Citigroup and Barclays Plc estimate.

Slump Continues

While the banks said Saudi Arabia’s strategy may weaken prices in the short-term, they forecast a recovery later. Commerzbank projects Brent will average $105 a barrel in 2015, Citigroup predicts $97.50. Brent for November settlement traded for $93.54 on the London-based ICE Futures Europe exchange as of 10:07 a.m. local time.
Aramco reduced official selling prices, or OSPs, for all grades of crudes to all regions for November. It lowered the OSP for Arab Light to Asia by $1 a barrel to a discount of $1.05 to the average of Oman and Dubai crude, the lowest level since December 2008. OSPs are regional adjustments Aramco makes to price formulas to compete against oil from other countries.
“OPEC appears to be gearing up for a price war,” Eugen Weinberg, head of commodities research at Commerzbank in Frankfurt, said in a report yesterday. “We therefore do not expect prices to stabilize until this impression disappears and OPEC returns to coordinated production cuts.”

Discourage Shale

The Gulf country plans to keep output steady until the end of the year, near the 9.6 million barrels a day pumped in August and September, a person with knowledge of the nation’s oil policy said on Sept. 26. It made the biggest cut to its production in 20 months in August, according to data the country submitted to OPEC.
Refraining from further cuts would preserve the volume of Saudi Arabia’s oil sales, curb revenues for competitors and discourage production of U.S. shale oil.
“U.S. producers may lay down rigs and slow production if WTI keeps falling below $90,” Jeffrey Currie, Goldman Sachs’s head of commodities research, said in an interview Oct. 1.
Prices are close to a level that would make production unprofitable for some companies in higher-cost locations such as North Dakota, he said.

Asian Contest

South American countries including Venezuela, Colombia and Ecuador have been exporting more crude to Asia as their traditional market, the U.S., becomes saturated with oil from shale wells and Canadian oil sands, according to data compiled by Bloomberg from Chinese customs data, the Petroleum Association of Japan and Korea National Oil Corporation.
“Asia is the main focus of the cuts,” said Amrita Sen, chief oil economist for London-based Energy Aspects Ltd. The main reason is to deal with aggressive marketing strategies from competitors, including Iran and Iraq, she said. “That’s what it’s heading to -- who blinks first?”
Iran dropped its OSP to Asia for Iranian Light to a premium of 18 cents a barrel to the average of Oman and Dubai crude in October, down from $3.96 in January and the lowest since November 2010. Iraq’s October OSP to Asia was a discount of $2.50 a barrel to the same crudes, the lowest level since January 2009.

Mechanical Decision

“We do not see evidence that this latest adjustment is an effort to lift production, avoid production cuts or punish other producers,” Adam Longson, an analyst with Morgan Stanley in New York, said in a note to clients.
Rather than signaling an impending fight for market share in Asia, the Saudis are probably adjusting for rising freight costs and falling prices of Atlantic Basin crudes, he said.
“The decision to reduce OSPs is in line with declining crude prices,” Harry Tchilinguirian, head of commodities strategy at BNP Paribas SA in London, said by e-mail. “There’s a mechanical aspect. If prices fall customers wouldn’t understand why you’ve maintained higher OSPs.”
While Asia is expected to be the fastest-growing consumer of oil, with demand expanding 44 percent through 2035 according to BP Plc (BP/), a battle for market share may be self-defeating, said Commerzbank’s Weinberg.
“Not only may such an action lead to lower prices, but more importantly, to lower confidence in OPEC’s power to control the price,” Weinberg said by phone today. “Then it will take years to get confidence back.”