When crude oil prices crashed into the $20 range early last year, it had most oil-producing nations quaking in their boots. That's because few countries can make much -- if any -- money at that price point. I say most because there are a handful of producers that were still able to make a tidy profit at that price point. Leading the way was Saudi Arabia.
According to data from energy industry consultant Rystad Energy, on average it cost Saudi Arabia less than $9 to produce a barrel of oil last year. That's the cheapest in the world, though fellow OPEC countries Iran and Iraq can produce for around $10 per barrel as well, which is well below rival nations:
Data source: Rystad Energy and The Wall Street Journal. Chart by author.
Here's a look at why Saudi oil is so cheap, and what one emerging rival is doing to catch up.
Drilling down into what makes Saudi oil so cheap
Rystad Energy looks at four data points when figuring out a nation's average cash cost to produce a barrel of oil: Capital spending, production costs, administrative and transportation costs, and gross taxes. Here's a breakdown of those costs per barrel for Saudi Arabia:
Data source: Rystad Energy and The Wall Street Journal. Chart by author.
As that chart shows, Saudi Arabia only needs to spend $3.50 in capital to pull a barrel of oil out of the ground. This amount includes money invested in drilling new wells as well as the associated equipment. The reason its capital costs are so low is that the country's oil is located near the surface of the desert and pooled in vast fields, so it doesn't need to invest that much in drawing it out of the ground. Contrast this with countries that have large offshore production bases like Norway and the U.K., which incur significantly higher capex costs of $13.76 and $22.67, respectively, due to the need to build large offshore production platforms.
Meanwhile, the location and size of Saudi's oil fields also help keep its production costs down. While it's not the cheapest in the world, as several nations have production costs around $2 per barrel, it's still a fraction of the production costs of a country like Canada, which pays $11.56 to produce a barrel of oil. One reason Canada's production cost is so high is that oil sands make up the bulk of its output, which are either produced through a process that burns natural gas to make steam or with large mining shovels and trucks to dig the oil sands out of the ground.
On a percentage basis, Saudi Arabia has some of the highest administrative and transportation costs in the world at 27.7% of the total. However, that's just because its other expenses are so low. When looking at those costs on a per-barrel basis, they are toward the bottom.
Finally, the lack of taxes is a significant competitive advantage for Saudi Arabia and other ultra-low-cost producers like Iran and Iraq. For perspective, if Russia didn't have to pay taxes, its cash costs for oil would decline from $19.21 to $10.77, which is much more competitive with its Middle Eastern rivals. That said, while these Middle Eastern nations don't tax oil production, they still get their cut because oil profits support a large percentage of their federal budgets. In fact, oil provided 62% of the revenue for Saudi Arabia's government last year and is expected to provide 69% in 2017 due to rising oil prices.
Image source: Getty Images.
How does shale compare?
For years Saudi Arabia had been the undisputed world leader in the oil market. However, thanks to advances in shale drilling technology, oil production in the U.S. recovered from years of declines, and at one point America overtook Saudi Arabia as the world's largest producer. In fact, shale drillers pumped out so much oil that the world became vastly oversupplied, which caused prices to crash. The Saudis didn't help matters, choosing to leverage their low costs into higher volumes to drive as many shale producers out of the market as it could.
That move, however, backfired, because it forced shale producers to become much more efficient, which led to a significant reduction in costs. That said, cash costs for U.S. shale are still more than twice those of Saudi Arabia due to higher expenses across the board:
Data source: Rystad Energy and The Wall Street Journal. Chart by author.
Still, those costs have steadily come down over the years, with capital spending seeing the biggest improvement. For example, last year oil production from leading shale producer EOG Resources (EOG -0.55%) declined less than 1% despite a remarkable 42% reduction in capital spending versus 2015. Fueling that capital efficiency was a significant decrease in EOG's completed well costs after drilling expenses in the Bakken dropped from $8.8 million in 2014 to $5.1 million last year, while those in the Delaware Basin plunged from $15.4 million to just $8.5 million over that same time frame. EOG used several techniques to reduce costs, including using data to drive well placement decisions, drilling longer wells and using more sand, and other innovations.
Production expenses, likewise, have come down sharply. In EOG Resources' case, its cost per barrel of oil equivalent has fallen 22% since 2014. Meanwhile, production expenses in the Permian Basin have dropped to as low as $2.25 per barrel, according to Pioneer Natural Resources (PXD -0.12%). Because of that, Pioneer Natural Resources' now-retired CEO Scott Sheffield said last year that "definitely we can compete with anything that Saudi Arabia has." That said, not all basins are quite that good, including former shining stars like the Eagle Ford and Bakken. However, shale is still in the early innings and has come a long way over the past decade, which suggests that companies could continue to innovate their way to even lower costs.
Investor takeaway
Saudi Arabia has the lowest oil production costs in the world thanks to two strategic advantages: Abundant pools of oil close to the surface and no taxes on production. Because of that, it can make money in almost any oil price environment. That said, Saudi Arabia made a mistake by trying to use its low costs to kill the shale revolution; it only made shale stronger.
