Streetwise Professor

January 13, 2015

Call Me Buffy

Filed under: Commodities,Economics,Energy — The Professor @ 7:31 pm

When it comes to the Saudi predatory pricing meme, I feel like Buffy the Vampire Slayer. No matter how many times I drive a stake through its heart, in the next episode it reappears in a different guise.

Here’s yet another example. 

I stipulate that the current low price environment is imposing substantial financial losses on shale producers. I further stipulate that they are currently slashing capex, which will lead to production growth declines at the least, and perhaps production declines  (depending on the race between reduced number of new wells and the increase in well productivity), while prices remain low. I stipulate further still that these effects would be reduced, if the Saudis had cut output to support prices.

Yet it does not follow that the Saudis are not cutting output because they are attempting to drive out shale producers. Because they can’t do so for long. The capital that is leaving the industry now can come back in when demand rebounds. This will limit the price upside, thereby depriving the Saudis of any payoff to recoup the losses they are incurring now.

Instead, the Saudis, just like everybody else in the industry, are coping with the consequences of a decline in demand the best way they can. Given Saudi market share, the elasticity of demand for oil, and crucially, the elasticity of supply of shale oil (which is relatively high, due to the relative flexibility of the technology and the availability of a large amount of prospects), the demand for Saudi oil is relatively elastic. This makes output cuts money losing: the cuts don’t increase price enough to offset the lower number of barrels sold. So keep producing, and pray for a demand turnaround.

Tune in soon for the next installment of Buffy the Saudi Conspiracy Theory Slayer. Alas, I think it will be a long running series, and there’s not a lot of variation in the plot lines, because the economics don’t really change.

Print Friendly, PDF & Email


  1. There is another somewhat amusing aspect to the whole story. Given that Russia oil output hits post-Soviet high , how come it is primarily the Saudis who are accused of “refusing to support the price”, the Russkis being [among] the loudest accusers?

    Comment by Ivan — January 14, 2015 @ 3:47 pm

  2. @Ivan-I’ve noted that particular bit of hypocrisy repeatedly, going back to 2008-2009. Another parallel between then and now.

    This is a general principle. Whatever the Russians complain about most hysterically, is exactly what they are doing for all they are worth.

    The ProfessorComment by The Professor — January 14, 2015 @ 6:59 pm

  3. Well, Saudis might be facing very elastic demand curve, so their unilateral cuts might be money losing, but OPEC cutting their production by say 10%, would move the price by more than 10%. For how long, it’s another question, given the likely widespread cheating in OPEC.

    Comment by Krzys — January 14, 2015 @ 10:50 pm

  4. @Krzys-If frogs had wings, they wouldn’t hop around on their asses. Yes, a coordinated OPEC cut could matter. But the Saudis know that everybody will cheat on their quotas, so it’s pointless to even go through the motions.

    If there’s a story here, that’s it: that KSA has basically written off OPEC and is going its own way.

    The ProfessorComment by The Professor — January 14, 2015 @ 11:16 pm

  5. Interestingly enough, even though Saudis might not believe in OPEC discipline, the market clearly did, as the thanksgiving drop proved.

    Comment by Krzys — January 15, 2015 @ 2:24 pm

  6. @Krzys-which is exactly why I thought that the market consensus pre-Thanksgiving was nuts.

    The ProfessorComment by The Professor — January 15, 2015 @ 3:59 pm

  7. I guess that’s why you are not a trader 🙂

    Comment by Krzys — January 15, 2015 @ 10:59 pm

RSS feed for comments on this post. TrackBack URI

Leave a comment

Powered by WordPress