WASHINGTON – Saudi Arabia’s oil end game is to let prices fall and stay low for as long as possible in order to kill the less competitive American shale oil producers. It is clear now that Ali al-Naimi, Saudi Minister of Petroleum and Mineral Resources, is betting on Saudi Arabia’s ability to force high cost US shale oil out of the market.
Conventional wisdom about shale oil
Here is the conventional wisdom. Sustained high oil prices encouraged American companies to exploit US shale oil deposits. This new US produced oil means less oil imported from Saudi Arabia.
While shale oil profit margins would not be huge, (extracting oil from shale is much more expensive than getting “conventional oil” in Saudi Arabia), as long as oil stayed at around $ 100 per barrel, the Americans could sell their crude at home, make money and displace Saudi imports.
But if oil prices went below $ 80 or $ 70 a barrel, there is no way that US shale producers could stay in business. Their production costs are just way too high.
Therefore, since Saudi Arabia’s production costs are much lower, it is smart to squeeze the new American competitors out by forcing oil prices down through over supply. Saudi Arabia still makes money with oil below $ 60 a barrel. But the Americans would not be able to stay in business and will be killed. Therefore let’s produce at full throttle, inundate the markets with excessive supply, and let prices go down and down. Unable to make any profit from their expensive oil, the US shale oil producers will simply go out of business. Saudi Arabia this way will regain its lost US market share.
What is the Saudis are wrong?
But what if the basic assumption about shale oil being unprofitable below $ 100, or below $ 90 is untrue? What if US shale oil producers can cut costs, and manage to survive and stay profitable even with oil below $ 60 per barrel?
Well, then we have entered a different era. The post-OPEC oil era. It would be really ironic if it turns out that Saudi Arabia’s effort backfired. Indeed what if the American shale oil industry will win by demonstrating that unconventional oil producers are in fact much stronger than anybody thought?
American ability to innovate
So, the real issue at stake here is American ingenuity and the ability of the US shale oil industry to cut costs and stay profitable, even when oil is below $ 60 per barrel. Is this possible?
Until yesterday everybody would have said “no”. My gut instinct is to say “yes”, it is possible. I am basing this optimism not on any insider knowledge of the new extracting technologies being rolled out, but on the industry track record so far.
It could not be done
Please do keep in mind that almost all energy experts have consistently underestimated the strength of the US “unconventional” oil sector. Until just a few years ago, the consensus was that shale oil would never be profitable. Too many technical hurdles that could be addressed only at a spectacularly high cost. Well, that was not true. Hydraulic fracturing (“fracking”) and horizontal drilling made shale oil extraction possible and profitable. In just a few years the US added almost 3 million barrels a day to its total production. Amazing.
Then it was said that, even if some shale oil could be extracted at a profit, (assuming oil at $ 100 per barrel), this “mini boom” would end soon, because there was not that much shale oil, while shale oil wells would yield very little compared to conventional oil deposits. Well, that was also proven wrong. Plenty of shale oil.
Enormous pressure to innovate
That said, can more and quickly deployed technological innovation keep the American shale oil industry in business? The pressure is both huge and sudden. Obviously the precipitous decline of oil prices forced everybody to go back to the drawing boards.
Is it possible to invent something new that will allow major productivity gains while reducing drilling and extraction costs? Can the US shale oil industry prove to be far more resilient than the Saudis assumed?
I do not know for sure. But, as I said, we have been surprised before, many times. The US energy industry is clearly engaged in a historic technological race, and it just may win.
If America wins
So, here is the picture. Saudi Arabia is trying to kill US shale oil producers, because their unexpected success is threatening its market share. But if the Americans manage to survive by demonstrating that they can make money even when oil prices hit bottom, and stay there, then they will kill OPEC.
Saudi Arabia needs high oil revenue to pay for everything
Indeed, let’s keep in mind that while Saudi Arabia is a low-cost, high volume producer, the Kingdom needs an enormous oil revenue (based on selling oil at or above $ 90 per barrel) to finance almost everything. While Saudi Aramco will stay profitable with oil at $ 50 per barrel, the Government of Saudi Arabia will not be able to function they way it is used to with a drastically diminished oil revenue. Less oil revenue means fewer subsidies for the poor, fewer investments in public services and infrastructure. In case you wonder, beyond oil Saudi Arabia has no other revenue.
I am really looking forward to the day in which Saudi Arabia, Russia, Iran and Venezuela will be hit hard by falling oil revenue. There is plenty of “unconventional” oil not just in America but around the world.
American energy companies may be able to prove that it is possible to extract it and make a profit even when oil prices are 50% below their peak. In so doing they will break the price-fixing power of the OPEC cartel which was based on the assumption that there is only a limited oil supply, while just a few countries control a huge chunk of it.