Beyond the Oil-Industry Bloodbath

Feb 24, 2016 By Bradley Olson WSJ
Executives from BP, Hess and Suncor strike a confident stance in a protracted period of low oil prices.

HOUSTON—Beleaguered oil and gas executives gathered here for a global energy conference sounded a common message: Blood may be in the water, but it isn’t ours.

Forced to reckon with a prolonged period of low energy prices, oil chiefs at the annual IHS IHS -0.27 % CERAWeek energy gathering sought to portray themselves as steely survivors in an industry grappling with spending cuts and asset sales

Many executives counted how many previous crashes they had weathered. Some took solace in the musings of “Persian wise men” and philosophers from the 19th century.

Industry leaders nonetheless were emphatic on two points: Their companies will pull through, and whenever the price rebound comes, they will be ready to take advantage of it.

“Times are tough, you’d almost call them brutal right now,” said Lamar McKay, BP BP -1.59 % PLC’s deputy chief executive. “But we will adapt. We will make it.”

The words at times seemed at odds with immediate financial realities, although many were taking a long view. BP, for example, reported a $5.2 billion loss in 2015 and earlier this month announced an additional 3,000 job cuts.

Hess Corp. HES -0.52 % chief executive John Hess touted his company’s survival prospects, saying among other things he sees lower costs than peers in North Dakota. Yet, the company saw a loss of more than $3 billion in 2015, its first in more than a decade.

“Our company has some of the best acreage,” Mr. Hess said. “We can be more resilient as prices recover.”

The mood reflects the realization that no cavalry is coming. Energy companies are likely to stay mired—for months if not years—in a global oil glut that has sent crude prices to $30 a barrel.

That became clearer Tuesday when Saudi oil minister Ali al-Naimi told a packed ballroom here that the kingdom had no plans to cut its output to boost prices. Instead, the world’s largest oil exporter is banking on market forces to drive out companies saddled with higher production costs. That, in turn, would reduce global supplies.

Mr. Naimi said his country was prepared to withstand $20 crude if needed to thin the herd.

Oil prices, which had rallied last week on news of a tentative agreement by Saudi Arabia, Russia, Venezuela and Qatar to freeze oil output before falling on Mr. Naimi’s comments Tuesday, edged 0.9% higher on Wednesday to $32.15 a barrel.

Energy companies have cut more than 300,000 jobs world-wide since mid-2014, when crude-oil prices began their tumble from $100 a barrel, according to Houston consulting firm Graves & Co. Globally, nearly $1.5 trillion of spending will be canceled from 2015 to 2019, according to IHS, a consulting and analytics firm. The spending cuts will push U.S. shale output down by 600,000 barrels a day this year and by 200,000 barrels a day in 2017, according to a forecast unveiled here on Monday by the International Energy Agency.

Troubled energy companies also can’t count on well-financed white knights to save them by writing fat checks for oil and gas acreage—at least not until oil prices show signs of stabilizing, said Bobby Tudor, CEO of energy-focused investment bank Tudor, Pickering, Holt & Co. “There’s just no money coming into the system,” Mr. Tudor said.

At least 48 North American oil and gas producers have filed for bankruptcy protection since the beginning of 2015, imperiling more than $17 billion in debt, according to law firm Haynes and Boone.

More are soon to follow, shale pioneer Mark Papa, the former CEO of EOG Resources Inc. and now a partner at energy-focused private-equity firm Riverstone Holdings LLC, told attendees. There will be “a lot of bodies, a lot of bankruptcies,” said Mr. Papa.

Saudi Arabia’s refusal to cut output could bankrupt as many as half of all shale producers, Scott Sheffield, CEO of Pioneer Natural Resources Co. PXD -0.20 % Not his company, though, he said Wednesday in an interview. Pioneer lost $623 million in the fourth quarter and has cut its 2016 budget to $2 billion. But, he also voiced his concern that the industry may not be in a position to take advantage of a rebound.

“When it’s time for us to respond in 2019 and 2020, we are not going to be able to respond quick enough,” he said.

The prevailing sentiment this week was certainly a departure from the swagger of previous years, when executives emboldened by high prices and the heady promise of shale oil touted multibillion-dollar expansion plans or “moonshot” drilling programs. Still, some CEOs sought to convey confidence that, while the industry may suffer, their companies were well positioned to ride out the storm.

“We will be one of the last guys standing,” said Steve Williams, CEO of Suncor Energy Inc., SU 1.39 % which is selling assets to raise cash for dividends.

While many speakers acknowledged the current hardship, they also took comfort in the idea of an eventual rebound, asserting that the era of low prices has chastened them.

Night is darkest before dawn, said Joe Kaeser, CEO of Siemens AG SIEGY -1.84 % . His remarks captured the Darwinian mood. To survive a bear attack, one needn’t outrun the bear, just out-sprint another person running for his life, Mr. Kaeser joked.

Former BP CEO John Browne, now executive chairman of L1 Energy, quoted German philosopher Georg Wilhelm Friedrich Hegel in expressing hope that the industry will be better prepared compared with past crashes once prices rebound.

“Hegel says if there’s one thing history teaches you, it’s that history doesn’t teach you anything,” Mr. Browne said. He added: “I hope that we will actually do the things that we can do properly and just don’t get carried away as we did during the high prices.”

—Erin Ailworth, Alison Sider and Chester Dawson contributed to this article.

Write to Bradley Olson at Bradley.Olson@wsj.com

Saudi Arabia’s Plan to Extend the Age of Oil

Saudi Arabia’s Plan to Extend the Age of Oil

The biggest exporter has let prices plummet—delaying the day when climate concerns, efficiency, and fuel switching break the world’s dependence on crude.

Last fall, as oil prices crashed, Ali al-Naimi, Saudi Arabia’s petroleum minister and the world’s de facto energy czar, went mum. He still popped up, as is his habit, at industry conferences on three continents. Yet from mid-September to the middle of November, while benchmark crude prices plunged 21 percent to a four-year low, Naimi didn’t utter a word in public.

For 20 years, Bloomberg Markets reports in its May 2015 issue, the world’s $2 trillion oil market has parsed Naimi’s every syllable for signs of where supply and prices are heading. Twice during previous routs—amid the Asian financial crisis in 1998 and again when the global economy melted down 10 years later—Naimi reversed oil’s free fall by orchestrating production cutbacks among members of OPEC. This time, he went to ground.

Bloomberg Markets

This story appears in the May issue of Bloomberg Markets.

At the cartel’s semiannual meeting on Nov. 27 in Vienna, Naimi shot down proposed output reductions supported by a majority of the 12 members in favor of a more daring strategy: keep pumping and wait for lower prices to force high-cost suppliers out of the market. Oil prices fell a further 10 percent by the end of the next day and kept going. Having averaged $110 a barrel from 2011 through the middle of 2014, Brent crude, the global benchmark, dipped below $50 in January.

“What they did was historic,” Daniel Yergin, the pre-eminent historian of the oil industry, told Bloomberg in February. “They said: ‘We resign. We quit. We’re no longer going to be the manager of the market. Let the market manage the market.’ That’s when you got this sort of shocked reaction that took prices down to those levels we saw.”

Naimi, 79, dominated the debate at the November meeting, according to officials briefed on the closed-door proceedings. He told his OPEC counterparts they should maintain output to protect market share from rising supplies of U.S. shale oil, which costs more to get out of the ground and thus becomes less viable as prices fall. In December, he said much the same thing in a press interview, arguing that it was “crooked logic” for low-cost producers such as Saudi Arabia to pump less to balance the market.

Supply was only half the calculus, though. While the new Saudi stance was being trumpeted as a war on shale, Naimi’s not-so-invisible hand pushing prices lower also addressed an even deeper Saudi fear: flagging long-term demand.

Naimi and other Saudi leaders have worried for years that climate change and high crude prices will boost energy efficiency, encourage renewables, and accelerate a switch to alternative fuels such as natural gas, especially in the emerging markets that they count on for growth. They see how demand for the commodity that’s created the kingdom’s enormous wealth—and is still abundant beneath the desert sands—may be nearing its peak. This isn’t something the petroleum minister discusses in depth in public, given global concern about carbon emissions and efforts to reduce reliance on fossil fuels. But Naimi acknowledges the trend. “Demand will peak way ahead of supply,” he told reporters in Qatar three years ago. If growth in oil consumption flattens out too soon, the transition could be wrenching for Saudi Arabia, which gets almost half its gross domestic product from oil exports.

Last week, in a speech in Riyadh, Naimi said Saudi Arabia would stand “firmly and resolutely” with others who oppose any attempt to marginalize oil consumption. “There are those who are trying to reach international agreements to limit the use of fossil fuel, and that will damage the interests of oil producers in the long-term,” he said.  

U.S. State Department cables released by WikiLeaks show that the Saudis’ interest in prolonging the world’s dependence on oil dates back at least a decade. In conversations with colleagues and U.S. diplomats, Naimi responded to the American fixation on “security of supply” with the Saudi need for “security of demand,” according to a 2006 embassy dispatch. “Saudi officials are very concerned that a climate change treaty would significantly reduce their income,” James Smith, the U.S. ambassador to Riyadh, wrote in a 2010 memo to U.S. Energy Secretary Steven Chu. “Effectively, peak oil arguments have been replaced by peak demand.”

Saudi
Alex Nabaum/Bloomberg Markets

The Saudis, to be sure, never thought much of peak oil. That’s the theory that global crude supplies, on an upward trajectory for a century and a half, were about to stop rising and could no longer keep up with demand. A faction of geologists and environmentalists made this argument part of the policy debate in the early years of this century. In 2005, when a book by oil analyst Matthew Simmons predicted a drop-off in Saudi output would signal that global supplies were beginning an irreversible decline, Naimi belittled the claims and promised higher production capacity. He won the argument. The Saudis pump more today than a decade ago. Saudi oil fields boast state-of-the-art technology, and at least two of them, in the middle of the desert, have gourmet restaurants. U.S. output has had a stunning rise as well, to more than 9 million barrels a day at the end of 2014 from less than 6 million five years ago. The peak that has the Saudis more worried is peak demand.

Before oil prices tanked last year, Saudi officials were bracing for global demand to level off as soon as 2025, says Mohammed al-Sabban, a senior economic adviser to the Saudi petroleum minister from 1988 to 2013. By letting prices fall, they may have bought themselves some time. At $60 to $70 a barrel, peak demand gets pushed back at least five more years, according to Bank of America Merrill Lynch commodities researchers. Such a delay would be bad news for renewable energy companies and for anyone hoping to bend the demand curve lower—slowing or stopping the relentless rise of global oil consumption that has transformed the planet since the first commercial deposit was developed in Pennsylvania in the early 1860s.

Crude prices above $100 a barrel had been bringing a demand peak closer. “The past four years were a disaster for oil producers in terms of energy market share,” says Sabban, who was also Saudi Arabia’s chief international climate negotiator. “Emerging economies are getting more efficient and diversifying their energy sources. That has definitely impacted oil consumption.”

Saudi officials were in a state of “near panic” last summer, when they recognized how quickly demand growth in China was leveling off, in part because of persistently high crude prices, says Ed Morse, Citigroup’s head of commodities research. “Naimi saw the era of frantic fixed-asset investments in China was over,” says Morse, a former deputy assistant secretary of state for international energy policy, who still communicates regularly with Gulf Arab officials. “That translates to the end of rapid urbanization, the end of doing things in unbelievably energy-intensive ways.”

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Substitution of lower-cost fuels is also taking a toll. Chinese diesel demand, after rising an average of 8 percent a year for a decade, actually fell in 2013 and 2014. The International Energy Agency attributes this partly to the country’s rapidly expanding fleet of natural gas vehicles. Chinese demand for oil this year is expected to rise to 10.6 million barrels a day, an increase of 2.6 percent, or half the average annual growth of the past decade and one-sixth the rate in 2004. China’s oil use is still climbing twice as fast as global consumption, but the IEA has in the past year shaved 500,000 barrels from its 2019 China demand forecast. More efficient autos and factories reduced the overall oil intensity of China’s economy—oil burned per unit of GDP—by 18 percent from 2008 to 2014. “If I were in Naimi’s shoes, I’d do exactly what he’s doing,” Morse says.

Naimi, who for the past five years has been telling friends he’s ready to retire, faces big risks as he sees through one more dramatic market realignment. His refusal to put Saudi Arabia and OPEC once again in the swing producer role, cutting supply to balance the market, hurts economically troubled member states that most need a price rebound. In Venezuela, where the economy is teetering and foreign-exchange reserves are depleted, oil’s collapse blows a bigger hole in the government budget and deepens the crisis. Iran, which needs high prices to help offset the effect of sanctions that have choked off its exports, has had harsh words for the Saudi-led policy. Persian Gulf producers should try to halt the decline in prices, a deputy foreign minister said on state-run television in January, and Foreign Minister Mohammad Javad Zarif delayed a meeting with his Saudi counterpart due to the discord. Regional tensions were highlighted in late March, when Saudi Arabia led airstrikes against Yemen’s Houthi rebels, seeking to counter Iranian influence there. 

Venezuela faces a deepening economic crisis as low oil prices strangle export revenue. Caracas residents line up outside a store for scarce groceries.

Venezuela faces a deepening economic crisis as low oil prices strangle export revenue. Caracas residents line up outside a store for scarce groceries.

Cristian Hernandez/Anadolu Agendy/Getty Images

Even Saudi Arabia, with more than $700 billion in reserves, could suffer financial strain if oil prices stay low for several years. The kingdom, with a population of about 30 million, spends lavishly on domestic programs and foreign aid. When King Salman ascended to the throne in January, after the death of King Abdullah, he promised in his first speech to improve education and expand health care. The Saudi budget was in deficit in 2014, despite strong oil prices for most of the year. The government forecasts a 2015 budget gap of 145 billion riyals ($39 billion), and it will be wider if oil prices don’t rebound.

Still, Naimi has said several times since the November meeting that he doesn’t know how low prices might go or when they will recover—and that the Saudis are willing to wait and see. Naimi’s concerns for Saudi Arabia are further in the future.

“Our ultimate aim is to diversify away from our overreliance on oil revenues,” the petroleum minister said at a 2013 seminar in Washington. The centerpiece of that effort is the establishment of the King Abdullah University of Science and Technology on the Red Sea, north of Jeddah. Naimi, who was CEO of state oil producer Saudi Aramco before becoming petroleum minister, recounted how, at a council of ministers meeting in 2006, the monarch took his hand and asked if he could build a university. “I said: ‘Your Majesty, we have­ built—I mean, Saudi Aramco has built—a lot of refineries, gas plants, pipelines, some housing. But universities? No. But we can, if you want.’ And we did.”

Ali al-Naimi

At OPEC’s November meeting in Vienna, Ali al-Naimi refused to sign on to a proposed reduction in output meant to boost prices as the cartel has done in the past.

Samuel Kubani/AFP/Getty Images

The school’s mission, as Naimi articulates it, is nothing less than to lead Saudi Arabia into the post-hydrocarbon age. The campus, built for 220 professors and 2,000 graduate students, is a bastion of tolerance and religious liberty in a country often criticized for having neither. Heavily armed guards on land and at sea protect the facility, where unveiled women study and work side by side with men, undisturbed by the religious police who patrol Saudi cities. Research there is aimed at scientific and commercial breakthroughs using those things Saudi Arabia has in abundance, such as sun, sand, and saltwater. When he discusses retirement, Naimi says it’s to devote more time to the institution.

While the university is key to Saudi Arabia’s diversification effort, there are other initiatives for the nearer term. The kingdom already is exploiting its huge deposits of phosphates to export fertilizer and is mining bauxite to smelt and roll aluminum. Eventually, Naimi says, Saudi Arabia wants to manufacture finished goods such as car parts. “We are generating job opportunities for our young people, encouraging enterprise, and providing the right environment for innovation and progress,” Naimi said at the Washington seminar. “It’s not easy, and it will not happen overnight. But it is happening.”

How much time Saudi Arabia has to prepare for the eventual decline of the oil era may depend, in part, on how alternatives fare during this period of cheap oil. Will sales of wind turbines and solar panels stay strong? Or will they enter a tailspin like they did during the Great Recession, when project financing dried up? And will sales of electric vehicles continue to climb even as gasoline prices slump?

Adam Sieminski, head of the U.S. Energy Information Administration, said at a Washington forum in late January that lower crude prices wouldn’t slow development of wind and solar power because there’s little direct competition with oil in electricity generation. Electric vehicles, he said, are helped by tax incentives and government policies and perhaps also by the cachet of green technology.

“The Saudis may be once again trying to prolong the age of oil,” says Bill McKibben, the author and environmental activist who has helped lead the campaign to block the Keystone XL pipeline, which would bring oil from Canada’s tar sands to the U.S. market. “But it feels like the steady, relentless fall in costs for renewables may make this different from other cycles.”

Naimi, who carefully manages his public comments the way a central banker or top diplomat might, hasn’t said how close he thinks the world may be to a peak in oil demand. He didn’t respond to requests to be interviewed for this story. But he has articulated his view that the crude market can no longer be understood without considering the effects alternative energy sources are having. “One has to be realistic,” Naimi told the Middle East Economic Survey in an interviewpublished in December. “There are many things in the energy market—not the oil market—that will determine prices in the future. A lot of effort is being exerted worldwide, whether in research or boosting efficiency or using nonfossil fuels.”

SAUDI WIRE CHART 3

Ali bin Ibrahim al-Naimi has lived the post-World War II history of oil—and done much to shape it. Born in 1935 in Saudi Arabia’s oil-rich Eastern Province, he spent his early childhood as a desert nomad, moving from spring to spring with his extended family and their livestock. When Naimi was 8, his Bedouin mother sent him to live with his father in the provincial capital of Dammam. He attended a school operated by Arabian American Oil Co., known as Aramco. The petroleum producer was founded by Standard Oil of California in the 1930s and became Saudi Aramco after its nationalization in the 1970s.

At 12, Naimi became a mail boy at Aramco, taking over for his brother after his sudden death, and he quickly shined as a star typist. One day at the Aramco offices, the American CEO stopped Naimi in the hallway and asked the teenager what he wanted to do with his life, says Peter van de Kamp, who became friends with Naimi at Lehigh University, recounting a story Naimi told their classmates in the early 1960s. “Well, sir, someday I would like to have your job,” Naimi answered. “If that’s the case,” the American said, “you’ll need an education.”

Aramco sent Naimi to school in Beirut and then to Lehigh in Pennsylvania and Stanford University in California, where he earned a master’s degree in geology. At Lehigh, the chair of the geology department assigned the 6-foot-5-inch Van de Kamp to watch out for Naimi, who’s around 5 feet tall. The transfer student from a Mideast country few students had heard of was a good companion, Van de Kamp says, respectful of Christians and Jews, comfortable socializing with women. He was eager to chop firewood and “get his hands dirty” doing chores at the Van de Kamps’ New Jersey home on holidays, he says. Proud of his Bedouin roots, Naimi told stories about tending sheep and goats in a forbidding desert with scarce food or water. He did his senior research project in 1962 on the commercial mining potential of New Jersey’s beach sand. “Ali was a comer­; we all could see it,” says Van de Kamp, who’s now a geologist in Oregon.

After returning to Saudi Arabia, Naimi zoomed through a series of oil production and executive positions at Aramco, culminating in his 1984 appointment as the company’s first Saudi president and, four years later, its CEO. At the time, U.S. and European consumption was in decline, due in part to sluggish economic growth and conservation measures adopted after the oil shocks of the 1970s. In response, Petroleum Minister Ahmed Zaki Yamani slashed Saudi oil output from 10 million barrels a day in 1981 to just 3.5 million in 1986. Prices kept falling, briefly getting to around $10 a barrel, as non-OPEC producers and cartel members cheating on their quotas filled the gap. In 1986, King Fahd fired Yamani, and the Saudis flooded the world with cheap oil to seize back market share—and induce Americans to resume their gas-guzzling habits. (The era of big SUVs was just beginning.)

Aramco’s new president saw firsthand what happened when the Saudis cut output and others didn’t, a lesson he cites today. “We will not make the same mistake again,” he said in Berlin in March.

SAUDI WEB CHART 1A

Promoted to petroleum minister in 1995, Naimi spends weekdays working in Riyadh and weekends at his family’s villa or at a small farm near Dharan. He arrives early each day at the ministry, a set of nine-story stone and black-glass blocks. His seventh-floor offices aren’t grand, the decor little changed in 20 years. He leaves in a black Mercedes by 2 p.m., Saudi government quitting time, and works the rest of the day at home.

Naimi’s tenure got off to a rough start. With demand rising in China, he persuaded OPEC to expand production in November 1997, just as the Asian financial crisis was deepening. During the next two years, oil prices fell 50 percent.

He also mishandled Saudi Arabia’s overture to Western energy companies to help develop the kingdom’s natural gas reserves. By 1998, then-Crown Prince Abdullah was trying to lure back foreign firms to tap Saudi gas for industrial projects such as electricity generation, water desalinization, and petrochemical manufacturing. Naimi, however, kept the best gas fields for Aramco while offering Exxon Mobil and dozens of other companies blocks that some Saudi geologists doubted contained much commercial gas, according to Sadad al-Husseini, who led Aramco’s exploration and production operations from 1985 to 2003.

The Exxon Mobil negotiations blew up in 2003, at the home of Saudi Foreign Minister Saud al-Faisal in Beverly Hills, California, according to journalist Steve Coll’s book Private Empire: ExxonMobil and American Power, published in 2012. Exxon Mobil’s then-CEO Lee Raymond informed Faisal and Naimi that the Saudi field on offer didn’t have enough gas to warrant his investment, Coll wrote. Naimi responded that Exxon Mobil’s experts were playing down the block’s potential to get a better deal. At that point, Raymond exploded at Naimi for questioning his people’s integrity, and the deal soon fell apart, Coll wrote. “I was very unhappy,” Raymond says in an interview. “The reality was that there was never access to the potential reserves you would need to support the project.”

Over time, Naimi earned a reputation as a straight talker and a shrewd manager of the global market. Despite the Saudis’ dire warnings to President George W. Bush not to invade Iraq in 2003, Naimi kept markets stable by promising to pump more oil during the war. In 2008, as prices soared to a record $147 a barrel, he resisted intense U.S. pressure to raise output again. Judging shrewdly that market conditions were very different than they were five years earlier, he argued in several contentious meetings with American officials that supply was adequate and that financial speculators were driving up prices. “The line was clear and consistent, even if it wasn’t a message the American administration wanted to hear,” says Ford Fraker, the U.S. ambassador to Riyadh from 2007 to 2009 and president of the Middle East Policy Council.

Iran has been exporting less because of international sanctions, making the decline in the price of crude an even worse blow to its economy.

Iran has been exporting less because of international sanctions, making the decline in the price of crude an even worse blow to its economy.

Kaveh Kazemi/Getty Images

During the Libyan uprising in May 2011, U.S. officials flew into Saudi Arabia to seek Naimi’s help replacing lost Libyan production. Naimi asked OPEC to expand its output ceiling at the cartel’s meeting that June, but the ministers stormed out of the Vienna secretariat without an agreement. The rebel members, led by Iran, didn’t want to agree to a higher target because they had little excess capacity that could be brought on line. They objected that the only countries with spare oil to sell were the cartel’s richest—Saudi Arabia, Qatar, Kuwait, and the United Arab Emirates.

Afterward, Naimi summoned the press to vent. He’d never seen such unreasonable obstinacy, said the minister, seated in a plush chair in his hotel suite. He’d tried to persuade the others that demand for OPEC’s crude had long since surpassed the recession levels that prevailed when the target was last set in 2008. They wouldn’t listen.

After some dogged diplomacy, OPEC raised the quota at its next meeting. Oil prices spiked early in the Arab Spring, and then they declined through the rest of 2011.

“He’s a man of few words but none wasted,” says Daniel Poneman, the U.S. deputy secretary of energy from 2009 to 2014. “He really came through.”

Naimi was a study in inscrutability when the OPEC ministers gathered this past November in Vienna. That morning, he slipped out the back door of his hotel on the city’s Ringstrasse, trailed by a gaggle of reporters through the medieval backstreets. This brisk morning walk had become known as a moment when Naimi would share his thoughts, but he wasn’t talking. A little later, back at OPEC headquarters, impatient with a television crew’s badgering questions, Naimi lost his legendary cool. “Get the hell out,” he snapped.

Inside the closed-door session, the OPEC ministers sat in alphabetical order around a large rectangular table. Naimi, silver-haired and dressed in a dark suit, blue-purple tie, and matching breast-pocket handkerchief, was seated between Gulf Arab allies Qatar and the U.A.E. Across the table, Venezuela’s Rafael Ramirez opened the proceedings with a proposal for a production cut to be jointly implemented by OPEC, Russia, and Mexico, according to the officials briefed on the proceedings.

Russia, where Vladimir Putin confidant Igor Sechin, left, is chairman of state-controlled oil company Rosneft, saw the ruble decline almost in unison with the price of crude.

Russia, where Vladimir Putin confidant Igor Sechin, left, is chairman of state-controlled oil company Rosneft, saw the ruble decline almost in unison with the price of crude.

Sasha Mordovets/Getty Images

Naimi scoffed. He told the ministers that after 60 years in the industry, he knew from experience that Russia wasn’t reliable. In 2008, the Russians pledged to join OPEC’s supply cut during the financial crash, but they never did. And just two days earlier in Vienna, Naimi had attended an awkward meeting at which Vladimir Putin ally Igor Sechin, CEO of oil giant Rosneft, said Russia would agree to cuts, only to be overruled at the same meeting by Russian Energy Minister Alexander Novak.

Naimi next shot down an Algerian proposal, supported by seven member states, for a 5 percent output reduction levied only on OPEC producers. That might boost prices today, Naimi said, but wouldn’t solve OPEC’s longer-term problem with shale producers and declining demand growth. His reasoning prevailed, as usual.

Demand anxiety, always lurking in the Saudi psyche, had surged after U.S. President Barack Obama took office. At first, in 2009, Naimi told American diplomats he wasn’t worried that alternative energy sources would reduce oil use because global consumption was soaring, especially in China and India, according to U.S. diplomatic cables. But six months later, in Ambassador Smith’s 2010 memo to Energy Secretary Chu, the envoy said Saudi leaders “were caught off guard by the strength of the Administration’s initial statements about its desire to move to a post-hydrocarbon economy and end dependence on imported oil.”

Alarm was heightened, the ambassador reported, because the Saudis were just finishing a $100 billion expansion of their production capacity to 12.5 million barrels a day. “Saudi leaders are concerned that this oil may never be needed,” Smith wrote. “They are less concerned about price forecasts than our expectations of the scope and pace of changes globally.”

Other classified cables released by WikiLeaks described the Saudis as “obstructionist” and “schizophrenic” on curbing climate change—launching solar and carbon-sequestration projects at home while impeding multilateral talks abroad. “Part of the explanation for this schizophrenic position is that the Saudi Government has not yet thought through all the implications of a climate change agreement, in part because it may not fully understand the various demand scenarios,” Smith wrote after the 2009 U.N. climate change conference in Copenhagen.

While Copenhagen didn’t lead to any binding agreement, governments have tightened carbon emission limits and other environmental rules in the years since. Efficiency improvements have kept coming. And the Saudi government has been thinking through the implications.

Naimi had put off retirement because King Abdullah asked him to stay. After Abdullah’s death on Jan. 23, King Salman kept Naimi as petroleum minister to signal consistency in Saudi policy during the transition. Still, Naimi is likely to soon have more time to devote to his university and the industrial and technological transformation he envisions for his country. As an Aramco executive and then as a globe-trotting oil diplomat, Naimi has shown great talent for bridging the divide between Westerners and the kingdom’s traditional leaders. And he’s overseen a Saudi industry that is an engine of science and progress.

In 2010, Naimi escorted Chu to visit King Abdullah at his palace in the desert oasis of Rawdhat Khuraim. The elderly monarch was in a philosophical mood and took the opportunity to pose a few questions to the Nobel laureate physicist, says Smith, who went along for the visit.

“Tell me how the universe was formed,” the king asked, in Smith’s recounting. Chu patiently laid out the story of the Big Bang theory. “What does that mean for God?” the monarch said. Chu and Smith conferred for a moment on an appropriate, diplomatic response. “There are some things we know, and for other things, we have God,” Chu replied.

“And tell me, how did we get all this oil?” King Abdullah asked. As Chu described how organisms decomposed over millions of years, Naimi whispered in Smith’s ear, “I’ve told him this a hundred times.”

This story appears in the May 2015 issue of Bloomberg Markets. With assistance from Grant Smith in London. 

More articles on Saudi Arabia

Andy Hall & OPEC out of business. Time for a new way to Trade Oil.

How Oil Trading ‘God’ Hall Made Money as Crude Fell
By Bradley Olson – Dec 10, 2014, 6:18:09 AM

Andrew J. Hall, revered for anticipating major swings in the market, posted a 1 percent gain in his commodity hedge fund in November, according to people familiar with the matter. Photographer: Andrey Rudakov/Bloomberg
How does a renowned oil trader who bets on rising prices make money when crude plunges 18 percent in a month? By betting on the U.S. dollar at the same time.

Andrew J. Hall, revered for anticipating major swings in the market, posted a 1 percent gain in his commodity hedge fund in November, according to people familiar with the matter. Hall, who is leaving his longtime post as chief executive officer of Phibro LLC, the century-old commodities trading house now owned by Occidental Petroleum Corp. (OXY ▼ -3.29% 74.90), sees oil falling further as he focuses on his private fund.

“It’s a new era,” said Carl Larry, a former trader who is now a Houston-based director of oil and natural gas at Frost & Sullivan. “So many things have changed. This will be a chance for him to step back, assess the market, and maybe plot a comeback.”

The surprise rise at 64-year-old Hall’s Astenbeck Capital Management was driven by his bets on the greenback and a move to sell out of crude contracts before the worst of the rapid decline in prices, according to the people and his letters to investors in the $3 billion fund. A prolific art collector and Oxford University graduate, Hall is revered as a “god” by rival traders, according to “Oil,” a 2010 book by Tom Bower.

Known for his conviction that oil prices will rise in the long term and that U.S. shale drilling is overhyped, Hall still sees reasons for an oil rally — eventually. First he sees crude prices falling further to as low as $50 a barrel before recovering in the first half of next year, according to his Dec. 1 letter to investors.

Astenbeck, which posted losses in 2011 and 2013, is poised to finish the year up by as much as 7 percent, according to the people who asked not to be identified because the information isn’t public.

Phibro’s Fate

Andrew J. Hall, founder of Astenbeck Capital Management, right, and his daughter Emma Hall, stand for a photograph during the 21st annual Take Home a Nude gala and fundraiser for the New York Academy of Art at Sotheby’s in New York, U.S.. Photographer: Katya Kazakina/Bloomberg
The fate of Occidental’s Phibro has yet to be determined, with Hall’s departure making the future more uncertain. The oil company had already told employees this year that it planned to sell or close its energy trading unit by the end of 2014.

Phibro’s U.S. employees haven’t been active in trading for months and the overseas operations may be sold, the people said. Occidental announced plans in February 2014 to reduce exposure to proprietary trading, Melissa Schoeb, a company spokeswoman, said yesterday.

As CEO, Hall gained notoriety during the 2009 financial crisis for a nine-digit pay package while Phibro was owned by Citigroup Inc., igniting controversy over compensation at banks that had been kept afloat with federal funds.

‘Fool’s Errand’

The former trader for BP Plc anticipated oil’s rise to a record in 2008, and its subsequent fall, helping him land compensation near $100 million for three straight years. Before Phibro was bought by Occidental, it had been profitable every fiscal year since 1997 and in 80 percent of the quarters during that period. The trading house’s gains for those years amounted to $4.4 billion, according to data compiled by Bloomberg.

Saudi Arabia was correct not to cut production after last month’s meeting of the Organization of Petroleum Exporting Countries, Hall wrote to his investors on Dec. 1. The market is oversupplied, making any effort to sustain prices at $90 a barrel “a fool’s errand,” he said.

Too much has been invested in boosting output in recent years, particularly in U.S. shale formations where producers have drilled wells with cheap, borrowed money, he said. Hall has frequently said the oil boom is over-hyped and won’t last as long as the industry thinks. Low prices will run weaker shale operators out of business and lead to reduced spending on more costly developments such as those in Canada’s oil sands, deep-water drilling and Arctic projects, Hall said.

‘Reasonable Bet’

“As the oil industry and, more to the point, its investors and its lenders slam on the brakes and as low prices stimulate demand growth, the current glut will in time disappear — if not turn into a future shortage,” he wrote in his letter. “That at least is what the Saudis are counting on, and to us it appears a reasonable bet.”

Hall’s strategy in the past has often been to buy so-called long-dated oil contracts for delivery years into the future. He likes to invest when those futures are cheaper than current prices, because he believes oil will rise. Earlier this year, the futures contracts were selling for less than oil prices at the time.

In February, a futures contract for a barrel of December 2019 West Texas Intermediate benchmark crude was selling for $76 a barrel while current prices averaged $100. By July, those 2019 contracts were selling for $88. That represents a 16 percent gain. Astenbeck, which also invests in numerous other commodities, including precious metals, was up 19 percent through June, according to his investor letters.

Holding Off

In August and September, Hall told investors he’d cut risk and sold a number of oil contracts at the higher price, and planned to wait for the market to once again turn his way. Now, such futures contracts are selling above today’s WTI price of $62.53, an environment in which Hall in the past has held off investing, according to people familiar with his positions.

When prices fell, Hall invested in the dollar. Astenbeck’s 1 percent gain in November came as U.S. oil prices fell to the lowest level in five years. In that same period, the Bloomberg Dollar Spot Index, a gauge of the dollar’s strength against 10 major trading partners, rose 15 percent.

Hall’s departure from Phibro, where traders have cut their teeth for more than 40 years, and the potential for the unit’s closure rippled through trading circles yesterday, said Eric Rosenfeldt, a vice president at Virginia Beach, Virgina-based energy supply firm PAPCO Inc.

Phibro History

Among the most storied trading houses in history, Phibro helped create modern oil-trading markets, with more than 2,000 employees around the world at one time. In 1981, the firm was large enough to buy the investment bank Salomon Brothers. Founded in 1901 as Philipp Brothers trading metals and chemicals, Phibro dove into oil in 1973 when the Arab oil embargo caused prices to soar and left U.S. refineries searching for supplies.

Phibro’s original crude traders included Marc Rich, who would later gain infamy for breaking sanctions against Iran and fleeing the country to avoid federal indictments. Rich won a controversial pardon from President Bill Clinton. Thomas O’Malley, now the chairman of PBF Energy Inc., hired Hall for Phibro at a salary of $135,000, he told reporters last month.

“You expect to see some trading shops come and go in energy trading, but there are some staple firms like Phibro that have been around such a long time, and created so many good professionals throughout the industry,” Rosenfeldt said by phone. If its doors eventually close, “it would certainly be the end of a very long era.”

Brent Plunge To $60 If OPEC Fails To Cut, Junk Bond Rout, Default Cycle, “Profit Recession” To Follow

Brent Plunge To $60 If OPEC Fails To Cut, Junk Bond Rout, Default Cycle, “Profit Recession” To Follow

NOVEMBER 24, 2014 AT 8:01 AM
Zero Hedge / Tyler Durden

While OPEC has been mostly irrelevant in the past 5 years as a result of Saudi Arabia’s recurring cartel-busting moves, which have seen the oil exporter frequently align with the US instead of with its OPEC “peers”, and thanks to central banks flooding the market with liquidity helping crude prices remain high regardless of where actual global spot or future demand was, this Thanksgiving traders will be periodically resurfacing from a Tryptophan coma and refreshing their favorite headline news service for updates from Vienna, where a failure by OPEC to implement a significant output cut could send oil prices could plunging to $60 a barrel according to Reuters citing “market players” say.

By way of background, the key reason OPEC is struggling to remain relevant is because, as the FT reported over the weekend, “US imports of crude oil from Opec nations are at their lowest level in almost 30 years, underlining the impact of the shale revolution on global trade flows. The lower dependence on imports from the cartel, which pumps a third of the world’s crude, comes amid advances in hydraulic fracturing that has propelled domestic US production to about 9m barrels a day – the highest level since the mid-1980s.”

The US “shale miracle” is best seen on the following chart showing the total output of the US compared to perennial crude powerhouse, Saudi Arabia:

It is this shale threat that has become the dominant concern for OPEC, far beyond whatever current US national interest are vis-a-vis Ukraine, and Russia’s sovereign oil revenues, and as reported previously, Brent has to drop below to $75 or lower for US shale player to one by one start going offline.

Unfortunately, it may bee too little too late for the splintered cartel. As Bloomberg reports, “the days when OPEC members could all but guarantee consensus when deciding production levels for oil are long gone, according to a veteran of almost two decades of the group’s meetings.”

The global glut of crude, which has contributed to a 30 percent decline in prices since June 19, has left the Organization of Petroleum Exporting Countries disunited and dependent on non-members to shore up the market, said former Qatari Oil Minister Abdullah Bin Hamad Al Attiyah. The 12-member group is set to meet in Vienna on Nov. 27.

“OPEC can’t balance the market alone,” Al Attiyah, who participated in the group’s policy meetings from 1992 to 2011, said in a Nov. 19 phone interview. “This time, Russia, Norway and Mexico must all come to the table. OPEC can make a cut, but what will happen is that non-OPEC supply will continue to grow. Then what will the market do?”

“OPEC had been enjoying easy meetings, and decisions were taken without a sweat,” Al Attiyah said. “Now the situation is different.”

Oil markets are oversupplied by about 2 million barrels a day, and global economic growth is below expectations, he said. “The U.S., which was a major market for OPEC, is no longer welcoming imports. It’s now striving to become an oil exporter. It’s already exporting condensates.”

So if OPEC is unable to reach an agreement, what is the worst case? Back to Reuters, which says that “The market would question the credibility of OPEC and its influence on global oil markets if there was no cut,” said Daniel Bathe, of Lupus alpha Commodity Invest Fund.

That could send Brent down to around $60, Bathe said.

“Herding behavior and a shift to net negative speculative positions should accelerate the price plunge,” he added.

Fund managers are divided over whether OPEC will reach an agreement on cutting output. Bathe put the likelihood at no more than 50 percent.

The oil price has been falling since the summer due to abundant supply — partly from U.S. shale oil — and low demand growth, particularly in Europe and Asia.

As a result, some investors believe a small cut — of around 500,000 bpd — would not be enough to calm the markets.

If OPEC fails to agree a cut, prices will drop “further and quite quickly”, with U.S. crude possibly sliding to $60, he said. U.S. crude closed at $76.51 on Friday, with Brent just above $80.

It’s not all downside: there is a chance that OPEC will agree on a 1 million barrel or more cut, which would actually send prices higher:

“The market really wants to see that OPEC is still functioning … if there is a small cut, with an accompanying statement of coherence from OPEC that presents a united front, and talks about seeing demand recovery, and some moderation of supply growth, then Brent could move up to $80-$90.” “Prices below $80 are putting significant strain on the cartel’s weakest members such as Venezuela,” said Nicolas Robin, a commodities fund manager at Threadneedle. He said a bigger cut — of 1 million bpd or more — was an “outlier scenario”, but such a move would rapidly push prices above $85.

Then again, even thay may be insufficient if the market prices in an ongoing deterioration in global end-demand: “Doug King, chief investment officer of RCMA Capital, sees Brent falling to $70, even with a cut of 1 million bpd.”

So in a worst case scenario, where Brent does indeed tumble to $60, what happens? We already know the answer, as it was presented in “If WTI Drops To $60, It Will “Trigger A Broader HY Market Default Cycle”, Says Deutsche”:

… it is not just the shale companies that are starting to look impaired. According to a Deutsche Bank analysis looking at what the “tipping point” for highly levered companies is in “oil price terms”, things start to get really ugly should crude drop another $15 or so per barrell. Its conclusion: “we would expect to see 1/3rd of US energy Bs/CCCs to restructure, which would imply a 15% default rate for overall US HY energy, and a 2.5% contribution to the broad US HY default rate…. A shock of that magnitude could be sufficient to trigger a broader HY market default cycle, if materialized. ”

This explains why the HY space has been far less exuberant in recent weeks, and the correlation between HY and the S&P 500 has completely broken down.

Finally it is not just the junk bond sector that is poised for a rout should there be no meaningful supply cuts later this week: recall that in another note over the weekend, DB said that should crude prices take another leg lower, then the most likely next outcome is a Profit recession, which while left unsaid, will almost certainly assure a full-blown, economic one as well.

So keep an eye on Vienna this Thanksgiving: the black swan may just be coated with an layer of crude oil this year.

Daniel Yergin: Why OPEC No Longer Calls the Shots

  • The Wall Street Journal
  • OPINION
  • October 14, 2013, 7:26 p.m. ET

Daniel Yergin: Why OPEC No Longer Calls the Shots

The oil embargo 40 years ago spurred an energy revolution. World production is 50% higher today than in 1973.

  • DANIEL YERGIN

Forty years ago, on Oct. 17, 1973, the world experienced its first “oil shock” as Arab exporters declared an embargo on shipments to Western countries. The OPEC embargo was prompted by America’s military support for Israel, which was repelling a coordinated surprise attack by Arab countries that had begun on Oct. 6, the sacred Jewish holiday of Yom Kippur.

With prices quadrupling in the next few months, the oil crisis set off an upheaval in global politics and the world economy. It also challenged America’s position in the world, polarized its politics at home and shook the country’s confidence.

Yet the crisis meant even more because it was the birth of the modern era of energy. Although the OPEC embargo seemed to provide proof that the world was running short of oil resources, the move by Arab exporters did the opposite: It provided massive incentive to develop new oil fields outside of the Middle East—what became known as “non-OPEC,” led by drilling in the North Sea and Alaska.

The Prudhoe Bay oil field was discovered in Alaska five years before the crisis. Yet opposition by environmentalists had prevented approval for a pipeline to bring the oil down from the North Slope—very much a “prequel” to the current battle over the Keystone XL pipeline. Only in the immediate aftermath of the embargo did a shaken Congress approve a pipeline that eventually added at its peak as much as two million barrels a day to the domestic supply.

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© Corbis

A Connecticut filling station in 1974 amid the oil embargo.

The push to find alternatives to oil boosted nuclear power and coal as secure domestic sources of electric power. The 1973 crisis spawned the modern wind and solar industries, too. By 1975, 5,000 people were flooding into Washington, D.C., for a conference on solar energy, which had been until then only “a subject for eco-freaks,” as one writer noted at the time.

That same year, Congress passed the first Corporate Average Fuel Economy standards, which required auto makers to double fuel efficiency—from 13.5 miles per gallon to 27 miles per gallon—ultimately saving about two millions barrels of oil per day. (The standards were raised in 2012 to 54.5 miles per gallon by 2025). France launched a “war on energy waste,” and Japan, short of resources and fearing that its economic miracle was at risk, began a drive for energy efficiency. Despite enormous growth in the U.S. economy since 1973, oil consumption today is up less than 7%.

The crisis also set the stage for the emergence of new importers that have growing weight in the global oil market. In 1973, most oil was consumed in the developed economies of North America, Western Europe and Japan—two thirds as late as 2000. But now oil consumption is flat or falling in those economies, and virtually all growth in demand is in developing economies, now better known as “emerging markets.” They represent half of world oil consumption today, and their share will continue to increase. Exporting countries will increasingly reorient themselves to those markets. Last month, China overtook the U.S. as the world’s largest net importer of oil.

A lasting lesson of the crisis years is the power of markets and their ability to adjust to disruptions, if government allows them to. The iconic images of the 1970s—gas lines and angry motorists—are trotted out whenever some new disruption happens. Yet those gas lines weren’t the result of markets. They were the largely self-inflicted result of government interference in markets with price controls and supply allocation. Today, the oil market is much more transparent owing to the development of futures markets.

The 1970s were also years of natural-gas shortages, which turned into a bitter political issue, particularly within the Democratic Party. Many at the time attributed these shortages to geology, but they too were the result of regulation and price controls. What solved the shortages wasn’t more controls but their elimination, which resulted in an oversupply that became known as the “gas bubble.” Today, abundant natural gas is the default fuel for new electricity generation. The lesson is that markets and price signals can work very efficiently, and surprisingly swiftly, even in crises, if they are allowed to.

There will be future energy disruptions because there is still much political risk around oil. In 2013, the Middle East is still in turmoil, but the alignments are different. In 1973, Iran was one of America’s strongest allies in the Middle East. Tehran didn’t participate in the embargo and pushed oil into the market. But since the 1979 Islamic revolution, Washington and Tehran have been adversaries. Meanwhile, Saudi Arabia, which was at the center of the 1973 embargo, is now America’s strongest Arab ally.

The real lesson of the shock of 1973 and the second oil shock set off by the overthrow of Iran’s shah in 1979 is that they provided incentives—and imperatives—to develop new resources. Today, total world oil production is 50% greater than in 1973. Exploration in the North Sea and Alaska was only the beginning. In the early 1990s, offshore production expanded farther out into the Gulf of Mexico, opening up deep water as a new oil frontier. In the late 1990s, Canadian oil sands embarked on an era of growth that today makes them a larger source of oil than Libya before its 2011 civil war.

Most recent is the development of “tight oil,” the spinoff from shale gas, which has increased U.S. oil output by more than 50% since 2008. This boom in domestic output increases energy supply, and combined with shale gas has a much wider economic impact in jobs, investment and household income. As these tight-oil supplies increase, and as the U.S. auto fleet becomes more efficient, oil imports have declined. Imports reached 60% of domestic consumption in 2005, but they are now down to 35%—the same level as in 1973.

As the U.S. imports less oil it also produces more to the benefit of energy security. There are several million barrels of oil now missing from the world oil market, owing to sanctions on Iranian oil, disappointments in Iraqi production, and disruptions to varying degrees in Libya, South Sudan, Nigeria and Yemen. The shortfall is being partly made up by Saudi Arabia, which is producing at its highest level.

But the growth in U.S. oil output has been crucial in compensating for the missing barrels. Without it, the world would be looking at higher oil prices, there would be talk of a possible new oil crisis, and no doubt Americans would once again start seeing images of those gas lines and angry motorists from 1973.

Mr. Yergin, vice chairman of IHS, is the author of “The Quest: Energy, Security, and the Remaking of the Modern World” (Penguin Press, 2012).

A version of this article appeared October 15, 2013, on page A19 in the U.S. edition of The Wall Street Journal, with the headline: Why OPEC No Longer Calls the Shots.

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