Is $30 oil irrational?

The Saudis think the price will rebound later this year. Oil traders disagree.

by Adam Gale
Last Updated: 23 Feb 2016

A barrel of oil should fetch more than $30 (£20.60), according to Khalid al-Falih, chairman of Saudi Aramco. The current price is ‘irrational’. Well he would say that, wouldn’t he? His point, made in a speech at Davos, is that the supply glut that’s brought crude to its recent lows is certain to be short-lived. Speculators should know that and should be pricing that in – and therefore pricing it up.     

They aren’t, of course, which is why the price is still low and the Saudi royal family is considered selling chunks of Falih’s company to pay for the country’s enormous deficit. The problem the Saudis face is that American shale rigs take a long time to mature. Yes, they’re very expensive and the low price engineered by Saudi overproduction is causing many of them to lose money on every barrel pumped, but the costs have already been sunk. As a result, it’s perfectly rational for them to keep on fracking - $30 is better than a kick in the teeth.

Falih predicted that American shale production would finally fall this year, leading to bankruptcy among many of the smaller, heavily indebted oil firms and lifting the price. That’s possible, but what does he expect will happen to the assets owned by those smaller firms? Others will be lining up to buy them, because the rising price will eventually make them lucrative again.

Fracking has made oil supply less responsive to price changes than before. If Saudi Arabia wants to maintain market share, then the oil price cycle will become longer and deeper, with troughs like the one we’re in now becoming a regular thing. That doesn’t benefit anyone, least of all the Saudis, whose obsession with market share – and the political power it brings them – is jeopardising their own economic future. That, more than $30 oil, is irrational.

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