Will America’s Shale Oil Kill OPEC? Saudi Arabia wants to keep oil prices very low, in order to smother US shale producers that need higher prices to stay in business. But the US shale industry will fight back

WASHINGTON – The incredible decline of world oil prices, (now at $ 66 per barrel), is due to three reasons. The first one is lower demand due to the prolonged economic slow down in Europe, in Japan, and to a lesser extent China. The second one is the significant increase of US domestic production –due to the massive development of shale oil– that caused a substantial decrease of US oil imports, this way adding to total supply available to other buyers. And the third one is Saudi Arabia’s ability to convince all OPEC members that, despite lower demand, the oil producers’ cartel should not cut supply in order to strengthen prices.

Market prices?

Well, what do you know, without artificial supply manipulation, it looks as if oil prices for a while at least will be determined by old-fashioned demand and supply.

Target US shale oil

That said, it is quite obvious that Saudi Arabia’s objective is to target US shale oil producers, in order to kill or at least weaken what the Saudis view as the major threat to their world energy dominance.

The Saudis bet that a prolonged period of low oil prices will put many small and medium-sized US companies that invested in shale oil out of business.

The conventional wisdom is that extracting oil from shale is very expensive. Therefore, it does not make sense to invest in shale unless oil prices stay above $ 80 per barrel.

By having all OPEC countries continue to produce at the same rate, Saudi Arabia is purposely flooding an already over supplied market, this way causing oil prices to fall more and more. The hope is that many, if not most, US energy companies extracting shale oil will go bankrupt or exit the sector, because it is assumed that they cannot make any money when oil prices are at $ 65 a barrel or lower.

So, Saudi Arabia is trying to kill the US shale revolution. Without this additional American production, OPEC will regain its ability to control prices through the manipulation of supply. Will this plan work?

Will US shale oil companies survive?

There is no question that many US small shale producers, especially those that carry huge debts, are doomed because they need oil prices at $ 65 per barrel, or higher.

However, many experts believe that most shale producers will survive this profit squeeze. As it always happens in a crisis, there will be painful consolidation. Smaller companies will be bought by bigger ones. Production will be concentrated in the shale regions where drilling is easier and cheaper. And there will be additional investments in cost cutting technologies and in enhanced recovery methods that allow companies to get more oil without the substantial cost of drilling many more wells.

In other words, as of now it looks that Saudi Arabia’s strategy aimed at killing the US shale oil sector will cause a lot of trouble, but that it will eventually fail.

Pain for OPEC members and for Russia

In the meantime, Saudi Arabia’s low oil price policies are inflicting a lot of pain on many OPEC members that heavily depend on oil revenue to finance most of their public spending. Iran and Venezuela will suffer greatly because their economies are weak, while their budgets are predicated on getting substantial revenue from high crude prices.

And Russia, not on OPEC member but a major oil producer, will also suffer because energy exports represent most of its revenue from foreign trade. Sure, Russia over time has accumulated substantial cash reserves. Therefore, it can finance current state spending by tapping these funds. The question is: for how long?

Indeed, should this low oil prices season go on and on, all bets are off. How long can Venezuela go on with a lot less oil money coming in? Ditto for Iran, and eventually for Russia. And even Saudi Arabia would have to revise its public spending plans, if it believes that its oil revenue will be curtailed for many years to come.

America bets on cost cutting technology

Here in America the hope is that the technological revolution that made shale oil production possible and profitable will continue. Or have we reached the limit on cost cutting innovation? I hope not. If you are a pessimist, please remember that until just a few years ago most oil experts believed that getting oil out of shale would never be profitable. 

That said, optimism alone is not enough. Obviously the long-term viability of the US shale oil sector hinges in large part on its ability to stay profitable by reducing production costs. If this proves to be an impossibility, then the high cost US shale sector will be vulnerable to price fluctuations, just like this one. If oil prices stay low indefinitely, US shale may eventually die, or at least production will be restricted to far fewer, lower cost areas.

Will America kill OPEC?

If technological progress will instead continue in the shale sector, then America will be the high volume, low-cost energy producer that killed OPEC. Assuming that US energy companies will be able to stay profitable with oil at current or even lower prices, increased supply of abundant and cheaper oil will benefit all energy products consumers across the world.