Has Saudis' bold gambit to let oil prices plunge worked?

LONDON (Bloomberg) - Three months after Saudi Arabia made clear it was going to let oil prices keep tumbling, the strategy is showing signs of working.

U.S. drillers are idling rigs at a record pace, gutting investment plans and laying off thousands of workers.

Those steps highlight how the Saudi-led OPEC decision on Nov. 27 to maintain output levels and protect its market share is having the desired effect - pushing prices down so far that they threaten to curb output in the U.S. and other non-OPEC countries.

Saudi Arabia, the most powerful member of the Organization of Petroleum Exporting Countries, will maintain that tack when the group next meets in June, according to some of the world's biggest banks.

The strategy "is working," said Francisco Blanch, head of commodities research at Bank of America in New York. "It is having the effect that we would expect, which is a decline in investment and ultimately supply, and somewhat higher demand."

The number of rigs drilling for oil in the U.S. dropped by 37 last week to 1,019, the fewest since July 2011, data from Baker Hughes Inc. showed Feb. 20. Since Dec. 5, a total of 556 have been taken out of service. Oil explorers including Royal Dutch Shell and Chevron Corp. have announced spending cuts of almost US$50 billion since Nov. 1.

Transocean Ltd., the world's largest offshore driller, had its credit rating cut to junk Feb. 25 by Moody's Investor Service on concern the company will increase debt levels while the drilling market deteriorates. It has about US$9 billion of borrowings.

Oil has rebounded 14 per cent in February, following a drop of more than 50 per cent since June, in part because of the decline in drilling, which signaled supply growth will slow. Lower prices also spurred demand from bargain hunters, putting European benchmark Brent crude on track for its first monthly gain since June.

Demand is growing and markets are "calm," Saudi Arabian Oil Minister Ali Al-Naimi said Feb. 27 in the Red Sea city of Jazan in the nation's southwest.

U.S. oil production will cease its month-on-month growth in April because of the drop in the rig count, Marios Maratheftis, the Dubai-based global head of research for Standard Chartered Plc, said in Dubai on Feb. 23.

The U.S. Energy Information Administration reduced its 2015 U.S. crude production forecast to 9.3 million barrels a day in February from 9.42 million in November. The EIA projects output will fall in the third quarter for the first time in four years.

"OPEC's long-game strategy is on track," Harry Tchilinguirian, head of commodity markets strategy at BNP Paribas SA in London, said by e-mail. "It's suffering short- term financial pain for long-term gain."

There is a cost to OPEC, of course.

Oil's plunge will reduce the group's revenue by about 37 per cent this year, according to the U.S. Energy Information Administration. Export revenues for 11 of OPEC's 12 members, excluding Iran, will shrink to US$446 billion in 2015 from US$703 billion in 2014, the EIA estimates.

Saudi Arabia's government said Dec. 25 that it expects a budget deficit in 2015 of 145 billion riyals (US$38.7 billion), up from 54 billion in 2014.

The Saudi strategy has been criticized by Venezuela, which the International Monetary Fund estimates will suffer an economic contraction of 7 per cent this year, and Iran, which the IMF says will be deprived of US$48 billion of revenues over two years. The Nigerian oil minister and current OPEC president, Diezani Alison-Madueke, said she may convene an emergency meeting of the group, the Financial Times reported Feb. 23.

There's no plan for such a gathering, according to a delegate who asked not to be named. OPEC's financially vulnerable members have little sway over policy because they're unwilling to cut production, leaving decision-making power with Saudi Arabia, according to Mike Wittner, head of oil markets research at Societe Generale in New York.

Even having its own way, Saudi Arabia isn't guaranteed success, according to Barclays. Global markets remain oversupplied, prices haven't fallen enough to press OPEC's rivals into cutting sufficiently and increasingly efficient shale producers could restore output, said Miswin Mahesh, an analyst at Barclays in London.

"It's still a very hard road," said Mahesh. "We haven't really seen an outright chunk of U.S. shale or any other high- cost production falling."

The U.S. pumped 9.29 million barrels a day in the week ended Feb. 20, the most in three decades, according to the EIA.

On the other hand, the International Energy Agency, a Paris-based adviser on energy policy to 29 developed nations, boosted its estimate of the world's dependence on OPEC in a Feb. 10 report, citing lower forecasts for other nations. OPEC will need to provide 600,000 barrels a day more in 2019 than the IEA predicted in its previous long-term outlook.

"If I'm sitting in Saudi Arabia, I'd say it looks like the plan is on its way to working," Wittner said. "It does need to be reflected in real supply. But all the signs are pointing in the right direction."