When a Price War Backfires - the story of the 2015-18 global oil market downturn

It made sense at the time. Flood the market with oil, force the global oil price down, and then drive the pesky shale producers out of the market. It was text book – which was a key part of the problem. All the Ivy League trained Saudi oil market experts followed the theories of the day in classic macroeconomic theory – only to have it backfire in a market altering way. While it is easy to critique someone else’s business decision way after the fact – which is not the point of this article – it is important to step back and learn from the experience in what will likely be viewed as one of the greatest globalization / pricing strategy backfires of this century.

Looking back (again, easy to do) the emergent shale industry was still a relative unknown in its competitive dynamic. There was minimal non-proprietary data in historic drilling costs and a lot of easy capital flying around such that it was hard to tell what were “economically viable projects” versus “good money after bad”. After all, with $100 oil – all projects looked good.

The reality was that back in 2014 the shale market was still immature – capital was still flowing in – and there was no incentive to cost optimize – with $100 oil. It was spend, drill, spend, drill. The traditional oil markets – like deep water and the Saudi oil fields – had already gone through multiple industry cycles and cost optimized years ago. The industry culture for conventional oil was cost optimization where conversely the industry culture for unconventional oil was – at the time – drill baby drill. Unconventional oil began in the depths of the Great Recession (2008) and unconventional producers had not yet gone through a downturn. Even as the 2014-17 downturn was ravaging the industry many shale CEOs were still compensated by their boards for achieving production targets. But that too changed and the shale producers significantly tightened their belts, cut costs, drove innovation in their drilling programs and reduced their break even points in the lower priced market environment.

So – and this is a big so – when Saudi Arabia (Aramco) made the strategic decision in 2014 to flood the market with supply – they likely thought they could drive the shale producers out of the market in about 12 months time – and regain their market share. (This kind of reminds me of reading history about WWI where the antagonists thought that it would be a short war and they’d all be home by Christmas). What the Saudi policy makers did not take into consideration is that the unconventional industry had significant slack and waste in their drilling programs (again, at $100 oil it was all about drilling) such that they could cost reduce by as much as 20, 30, 40 percent respectively – in order to be profitable at lower priced markets like $40 to $50 WTI oil. I don’t think anybody, including here in the U.S., saw this coming.

The lesson here is that before you start competing on price – in a market share war – you need to fully understand your competitor’s cost structure and how much room they have for further innovation. Also, you need to understand how long you can sustain a price war to kill off your competition – which I don’t think the Saudis did. For example, it costs about $10 USD to produce a barrel of oil in Saudi Arabia (the lowest production cost across the industry) but the country needs $70 oil in order to pay its social subsidies. In 2014 did any of the Saudi policy makers ask the question as to whether the country and government could sustain $40 oil (Brent) for three years in order to kill off shale? That is what it would have taken – perhaps 3 to 4 years – of excessively low pricing for Wall Street and investors to walk away from this market.

Competitive game theory (a hypothetical price war in this case) would have dictated that Saudi policy makers consider the likelihoods of all scenarios and assign a risk assessment to each. Could Saudi Arabia economically sustain $40 oil for four years (and their allies too – Bahrain and the UAE)? Did they consider this potential outcome when they reviewed their policy options?

Should’ve, would’ve, could’ve are easy words to say – but in hindsight I’d have to say that the risk of stabilization was not worth this price war in which Saudi Arabia – when all is said and done – will end up with a reduced market share, reduced government coffers, a changed society and as we expect – a publicaly traded Aramco. In the short term this has all been very painful but in the long term all these changes will likely lead to a healthier Saudi economy and society. Just like the shale producers, the Saudis too will adapt. Read the following link for insight on how this global competitive game theory is likely to play out.

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Peter Armstrong is a Principal with Armstrong Marketing Strategies, a B2B “sales results oriented” marketing and business development consultancy and services firm. Our services are offered on a fractional CMO or BD Executive basis or by project. We specialize in inbound marketing / marketing automation (either as an internally supported or outsourced solution) and formulating distinctive go-to-market strategies. Expertise spans branding, messaging, market research, web development, product marketing, new product development, trade show execution, sales force optimization, and solution selling sales training.

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