Saudi Arabia faced the choice of any head of family when the kids and cousins are running wild at the backyard bbq: You can get them in line by yelling and risk further non-compliance and climbing into the neighbors yard, or you could acquiesce and buy them all ponies. This week, Saudi went pony shopping and cut 1 Mmbo/d. The question everyone is asking is why.
My view is this.
- OPEC is fragile and without Russia, it collapses and with it price is in the $30s. There are 8 mmbo/d idled and demand doesn’t look that strong to me, despite the dancing of the bulls. Saudi is better off with 10% less production and 40% more price.
- Saudi is worried about European lockdowns, demand, products, new CV strains, delays in vaccine roll outs (you know.. everything the stock market doesn’t appear to be worried about).
- From March-May when world demand was down 25+ mmbo/d led to a huge increase in inventories. They are still high and we can’t see directly at what China’s economy is actually doing (you might not know this, but they lie about data). Saudi needs that inventory cleared out- a cut is the best way to manage it.
So what of the US producer? Smart companies are hedging like crazy and would be well served to moderate activity in H1. DUCs, as we have discussed represent a lot of stranded capital and on a sunk cost basis, yield the highest returns. A combination of shoring up cash flow with hedges, moderating declines with DUCs, and getting debt under control while searching for a dance partner (M&A) is the best strategy.
Alas… discipline has never been our industries strong suit, and I fear that we will look at this stroke of good fortune from Saudi and turn the carrot into the stick.
