Why does the US produce so much oil

America's deal with Saudi Arabia : Security for less oil

Josef Braml is the author of the blog usaexperte.com and heads the America program of the German Society for Foreign Policy (DGAP) - a think tank that advises politics and business in Germany and Europe.

Despite Trump's military “dominance” of energy and his “deal of the century” with the Saudis-led OPEC, oil prices have continued to slide, and even plummeted. In the meantime, the quotation of the reference price for US oil was even negative.

This downward trend threatens not only the US oil and gas industry, but also Trump's re-election, which depends on the well-being of the US economy and not least on the situation in highly competitive states such as Pennsylvania and Ohio, where American fracking is practiced -Industry is particularly hard hit.

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The enormous slump in oil demand in the wake of the Corona crisis, around 20 million barrels a day, threatens the existence of the already ailing fracking industry in the USA. Baker Hughes, one of the world's leading petroleum service companies, reported a further 66 fewer rigs in mid-April 2020 - the largest weekly decline since February 2015!

Last month the total decreased more than 35 percent to 529 holes still active in the US. This slump will have further effects, namely on the supplier industry. This is because the “rig count” is an early indicator of the demand for products that are used in the drilling, completion, manufacture and processing of hydrocarbons.

Price war against the co-producers

The concerns of the oil and gas production-dependent industry in the USA were all the greater when Russia's refusal to cut its production caused Saudi Arabia to once again go into the price war against co-producers, and with it the oil price all the more , squeezed below $ 30 a barrel.

Other US oil and gas companies and the 10 million jobs that depend on them were at risk and threatened to suffer even more from the US economy, which was affected by the corona epidemic.

Donald Trump, whose re-election and political fate depend on the well-being of the American economy, put enormous pressure on Saudi Arabia. He also received cross-party support from Congress.

US senators, who represent oil-producing states in Washington, even openly threatened to deny the oil monarchy the military protection of world power if Riyadh did not restrict its production and help American producers survive economically.

Oil demand and safety issues

Washington's connection with Riyadh, which has been tried and tested for decades (keyword: "security for oil"; now, since the US itself is again an oil exporter, ironically "security for less oil") and further talks with Moscow have paid off - for the time being - on April 12th In 2020, the Saudi Arabia-led OPEC producers agreed with Russia and the USA on volume restrictions.

From May 2020, production should be less, and in the first two months even a record reduction of almost 10 million barrels per day should be achieved, with Saudi Arabia and Russia taking over the lion's share.

Donald Trump believes himself to be the winner of this deal, because the US producers are not really affected by the US production restrictions: Due to the low market prices, they have to cut back their production anyway for economic reasons.

A deal at the right time

The deal came at the right time, drawing closer to the end of the month and thus also the deadline for future buy and sell options. The US reference price for West Texas Intermediate (WTI) oil is even turning negative for May. However, the price of June WTI oil fell only slightly and leveled off again at around $ 20.

US President Trump's announcement that he would buy up to 75 million barrels of crude oil to further replenish US strategic reserves reassured traders. In view of the deal with OPEC, too, they assume that prices should recover somewhat.

However, if prices rise again noticeably thanks to the agreed restrictions imposed by the other producers, production in America will probably rise above the agreed level again - and thus jeopardize the deal.

In order not to lose market share to US producers, Saudi Arabia and Russia would quickly ignore their production restrictions - not to mention OPEC states like Iraq and Nigeria, which in the past have not kept to agreements anyway.

Limitation of the offer

Contrary to what most experts expected, in 2015 the Saudis did not react to the increased production in the US fracking industry by limiting their supply in order to prevent the price decline.

Aware of their strategic advantage, which is that they can produce on far more favorable terms and have a longer stamina than the American competition, they have even increased their production in order to drive prices down further.

The price war at that time was already having an immediate effect. Many US companies were soon no longer able to cover their production costs. When the price of oil fell to just over $ 50 per barrel in the summer of 2015, the number of wells also fell to 645 - from over 1,500 that were counted a year earlier. Those responsible in Saudi Arabia have already ensured that the fracking bubble in the USA burst and the American energy market consolidated further.

Saudi Arabia with eagle eyes

Even if the “deal” stands, Saudi Arabia will watch out with eagle eyes to defend its market share in Asia - the most important demand region. Saudi Aramco, the kingdom's state-controlled oil giant, has diversified its prices regionally and set them lower for Asia.

Even beyond the provisional armistice, resource-hungry China is likely to be the main beneficiary of this price war. In the foreseeable fiercer struggle of the producers for the future shrinking demand, the power of the buyers and in particular that of the largest energy consumer, China, is likely to increase further.

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