Saudi producers have the money to hold out for two years, but U.S. can’t afford to let frackers fail
Gwynne Dyer is an independent London-based journalist whose articles are published in 45 countries.
I’m in Alberta, the province that produces most of Canada’s oil, and there’s only one question on everybody’s lips: How long
will the oil price stay down? It has fallen by more than half in the past nine months — West Texas Intermediate is $48 per
barrel today — and further falls are predicted for the coming weeks.
This hits jobs and government revenues hard in big oil-producing centres like Alberta, Texas and the British North Sea, but its effects reach farther than that. “Clean” energy producers are seeing demand for their solar panels and windmills drop as oil gets
more competitive. Electric cars, which were expected to make a major market breakthrough this year, are losing out to traditional gas-guzzlers that are now cheap to run again. Countries that have become too dependent on oil revenues are in deep trouble, like Russia (where the rouble has lost half its value in six months) and Venezuela. Countries like India, which imports most of its oil, are getting a big economic boost from the lower oil price. So how long this goes on matters to a great many people.
The answer may lie in two key numbers. Saudi Arabia has $900 billion in cash reserves, so it can afford to keep the oil price low for at least a couple of years. The “frackers” who have added four million barrels a day to U.S. oil production in the past five years (and effectively flooded the market) already owe an estimated $160 billion to the banks. They will have to borrow a lot more to stay in business while the oil price is low, because almost none of them can make a profit at the current price. Production
costs in the oil world are deep, dark secrets, but nobody believes that oil produced by hydraulic fracturing (“fracking”) comes in at less than $60-$70 per barrel. The real struggle is between the frackers and Saudi Arabia, because the latter is the “swing
producer” in OPEC (the Organization of Petroleum-Exporting Countries), the cartel that has dominated the global oil market for the past fifty years.
All oil exporters want to keep the price high, but Saudi Arabia was the one OPEC member that could and would cut its production sharply for a while when an over-supply of oil in the market was driving prices down. It could afford to do that
because it has a relatively small population, very large savings — and a cost of production so low that it can make some profit
on its oil at almost any price. But even the Saudis cannot work miracles. They can aim for maximum production or maximum price; they cannot do both at the same time. Normally they would cut production temporarily to get the price back up. This time they refused to cut production and let the price collapse, despite the anguished pleas of some other OPEC members that need money NOW. The Saudis are thinking strategically. OPEC only controls about 30 per cent of world oil production, which is a very low share for a cartel that seeks to control the price. If fracking continues to expand in the United States, then OPEC’s market share will fall even further. So it has to drive the frackers out of business now. At first glance the Saudis look like sure
winners, because they can live with low prices a lot longer than the deeply indebted frackers can. The banks that have lent the frackers so much money already won’t get it back if the industry implodes in a wave of bankruptcies, but they don’t want to throw good money after bad.
The real wild card here is the U.S. government, which wants the “energy independence” that only more domestic oil production through fracking can provide. Will it let the American fracking industry go under, or will it give it the loan guarantees and direct subsidies that would let it wait the Saudis out? Stupid question. Of course it will do what is necessary to save the fracking
industry. Ideology goes out the window in a case like this: you can get bipartisan support in Washington for protecting a key American industry from “unfair” foreign competition. That will certainly be enough to keep the frackers in the game for another two or three years. Meanwhile, the OPEC members that depend on oil income to keep large populations well fed and at least
marginally content (e.g. Iran, Nigeria and Venezuela) will be facing massive public protest, and possibly even the threat of revolution. Their governments will be putting huge pressure on Saudi Arabia to save them by cutting production and driving the price back up.
It’s impossible to say how this game will end, but it’s pretty easy to say when. Two years ought to do it. Once the outcome is clear, the price of oil will start going back up no matter which side wins, but it will go up relatively slowly. We are unlikely to
see $100-a-barrel oil again before 2020 at the earliest.
