In another crushing defeat for the oil bulls, the last two weeks have seen inventories screaming to the upside as weak demand combined with stable supply sees prices once again on the decline. Energy markets broadly remain oversupplied with the latest estimates showing that supply continues to outpace demand by nearly 1.5-2.0 million barrels per day. With the production glut set to continue as Middle East suppliers compete for buyers and strive to maintain market share, the risk of implosion of several dominant producers remains a real concern. While over the medium-term, policies concerning production are not forecast to change, the looming factor that could spell disaster for prices is declining global storage capacity. With the risks still broadly to the downside for energy prices, rising reserves could be the factor that causes the next slide in oil.
The Fundamental Picture
While the battle to unseat horizontal drilling and unconventional oil production has largely paid off with the American industry on the ropes, the exercise conducted by OPEC members has been a costly endeavor. Saudi Arabia in particular has felt the pinch as the government slashes costs and even postpones paying suppliers in an effort to shore up the capital position. Foreign holdings are being cashed out and money is being swiftly repatriated as policymakers struggle to pay bills and stay solvent. The Saudis are very likely to be forced to tap international bond markets in an effort to restore finances to a healthy level. While the nation still boasts substantial foreign currency reserves, these are being drawn down rapidly to protect the peg.
The Saudis are fighting wars on two other fronts and this is draining cash as an exceptionally fast pace. Besides funding to a degree the hostilities still underway in Syria, Yemen remains mired in conflict with no real end in sight. Moreover, despite estimates of extraction costs between $7-10 per barrel, the high level of entitlement spending required to protect the monarchy means anything less than $100 per barrel sees an increased risk of social unrest as the government fails to balance the budget. With no demonstrable expectations of a rebound in crude prices over the near-term, Saudi Arabia will be forced to engage in ever-increasing belt tightening to keep from going bankrupt. The emphasis on market-share is not productive from the standpoint that keeps prices depressed and creates additional enemies across the global energy landscape.
