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Saudi Arabia, Oil and Predatory Pricing

Sigma Investment Counselors

July 29, 2015

According to Wikipedia, predatory pricing is a pricing strategy where a product or service is set at a very low price, intending to drive competitors out of the market, or create barriers to entry for potential new competitors.  The objective of this strategy is to eliminate enough competitors to allow monopoly pricing in the future.

Saudi Arabia has been increasing oil production, despite apparent weaker demand and soft pricing.  Why?

There are probably several reasons.  By keeping the price of oil low, the Saudis may believe that they can slow or reduce shale oil activity, particularly in the U S.  This would be a clear example of predatory pricing.

The Saudis also appear to be attempting to reduce the oil revenues going to countries, such as Iran and Russia, which they perceive to be enemies.

A third goal may be an effort to maintain market share with major buyers during a period of surplus capacity and increased marketing efforts by competitors aimed at long-time key Saudi customers.

Regardless of motive, Saudi activity is affecting oil prices over the short run.  What happens longer term, is more complicated.  The Saudis may determine that their current strategy is not sustainable.  Perhaps other producers may be able to lower costs sufficiently to maintain or increase production, despite Saudi efforts to reduce prices.  Only time will tell.  However, investors should note that there seems to be a lot of oil around currently and the potential return of higher volumes from Iran could further aggravate the near-term excess supply situation.

All comments and suggestions are welcome.

Walter J. Kirchberger, CFA®

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