Gwynne Dyer: Fracking is winning and Saudi Arabia loses
“No one can set the price of oil. It’s up to Allah,” said Saudi Arabian Oil Minister Ali al-Naimi in May.
But less devout people believe that Saudi Arabia has been trying very hard to set the price of oil—and to set it low. Moreover, it has been remarkably successful, because last week the price of oil was in the mid $40s per barrel, down from just over $100 last May.
But Riyadh is not achieving its objective.
Saudi Arabia, like any oil producer, likes a high price for its oil, but since it is very rich and has huge reserves it thinks long-term. Watching American oil production almost double in the past seven years, mainly thanks to the rapid rise of fracking, the Saudis could see that they risked losing their role as the “swing producer” who can raise or lower the oil price just by cutting or increasing its own production.
The only way Saudi Arabia could keep that role was to drive the American frackers out of business. Production costs are secret in the oil world, but the Saudis assumed that the injection of water, sand, and chemicals into shale rock at high pressure makes hydraulic fracturing—fracking—very expensive.
So the Saudi strategy is to keep its own production high in order to push the the oil price down. If the price stays low enough for long enough, high-cost producers like the frackers will have to close down. Then, once the competition had been eliminated, Saudi Arabia jacks the price back up by cutting its own production, and the glory days return.
In the meantime Saudi Arabia is losing income too, of course, and oil revenues account for 90 percent of the national budget. It can live on savings for a while, but it needs a fairly quick win.
It would be politically unwise to cut the lavish government spending that keeps the Saudi population happy, and the government is also involved in an expensive war in Yemen. The missing income has mostly been replaced by withdrawals from the country’s huge foreign reserves, estimated a year ago at $700 billion—but those reserves have fallen by $65 billion in the past year.
The Saudis don’t want to run those reserves down too far: without them, it could not afford to play the role of “swing producer”, and would lose most of its diplomatic clout. So last week, for the first time in eight years, Saudi Arabia started selling government bonds, planning to raise $27 billion by the end of the year.
The strain is starting to show.
The strain of this attritional battle is also showing in the United States, where various shale oil producers have cancelled or postponed new drilling projects. But the shale producers have consolidated into bigger companies and increased the efficiency of their production processes, and U.S. oil production is actually continuing to grow this year. It is now at about 90 percent of Saudi production.
The brutal fact is that the Saudis are losing this battle. When the U.S. was the biggest producer of oil, before about 1970, it was the swing producer. Within a few years, it will have overtaken Saudi oil production and will be the swing producer again. And there is nothing Riyadh can do about it.
The Saudis made two mistakes. The first was to overestimate the cost of U.S. shale oil production, and assume that any price below about $80 per barrel would make it unprofitable. There are some shale oil plays for which this is true, but the costs vary wildly, according to the local geology, and can be as low as $20 per barrel. Most shale oil is profitable at $60 per barrel, and that proportion is rising rapidly as consolidation proceeds and efficiency rises.
Their other, bigger mistake was to believe that victory was possible at all. When you stop production from a conventional oil well, there is a large permanent loss of flow when you restart production. The pores in the oil-bearing rock clog up, and that permanently reduces the “bottom-hole” pressure that forces the oil to the surface.
Stopping production at a shale-oil site incurs no such loss, since the producers create the pressure themselves. Uncap it, and the flow resumes as before.
So even if the Saudis succeeded in forcing most of the shale-oil sites to close, the shale producers would just turn the flow on again as soon as Saudi Arabia declared victory and cut production to get the price of oil back up.
It will take a little more time to the Saudis to acknowledge their mistake, and they may not even be able to get the price back up to where they need it by cutting production. American production will continue to rise, and Iranian oil will probably also be coming back on the market in a big way by next year.
The Saudis will stay rich, but they will have to cut their spending and they will suffer a permanent loss of influence.
Their only consolation will be that Iran, which they see as their greatest enemy, won’t be able to use its oil to buy influence either.
Aug 19, 2015 at 6:24pm
Lets hope opec tries to regroup and get the oil around 60 - 80 to help solar and alternate energy..
Why haven't they made all roofs white or reflective?Its hard to stop the temp...Turn them off.
Aug 19, 2015 at 9:05pm
While I'll cry no tears to see a reduction in Saudi Arabia's malign influence, the price of fracking is high: Radon to give people in local communities lung cancer, methane leakage to provide a kick to climate change, and permanent contamination of ground water with fracking chemicals.
Aug 20, 2015 at 6:50am
Good to see the Arabs losing control of pricing. It may also result in a reduction in funding to Islamist organisations.
Dr Tom Williams
Aug 20, 2015 at 7:57am
I retired but 60 years ago I worked a rig in eastern Kansas...then went on through the Mid East..India...China..Mongolia....This article is so self-centered to the US without recognizing the Saudis are not new to this game and are big employer/listening post in Houston...They are not set for the US and have proven it several times....remember the rest of the world... KSA is worried about market shares in Europe and China and their other competitors - Russia (Non-OPEC), returning Iran (other OPEC), and the unruly Venezuelans, Nigerians, Iraq, and other smaller cats that they herd...in the background they also see the renewables coming up faster than they thought in 2000.... So they chose to return to their market dominance....One choice but covered many bases and maybe even helped the European over the current slump....It is the World Market stupid...they know Texas oil but they also know Russian Oil even better....My hard hat is off to them again....they learned in the 70s about the market and they learned alot since...one simple "little" move and many problems solved...they got the money, banks, and resources to weather 3-5 years...better than some I have seen in 2015.
Aug 20, 2015 at 8:23am
US oil producers have dealt a nice financial blow to the Middle East oil barons.
It would be in the long term interests of the US to have a coherent overall energy program that helped transitioned to a post hydrocarbon renewable energy source.
Real leaders would take advantage of this "fracking bonanza" to usher in the clean, renewable energy future.
Aug 20, 2015 at 9:55am
I'm not sure why they would view the US as a swing producer. There oil is control by a bunch of companies each focus on their own short term profits. Even if they became the largest producer again they wouldn't really control anything, they would just follow the market like good capitalists.
Aug 20, 2015 at 10:00am
In trying to figure out why the Saudis would manipulate the price of oil to be so drastically lower, I have been wondering it they were doing it for reasons internal to the Middle East. They want to hurt Iran, and to hurt the economies of the Shia states in general, and I had concluded that they were willing to hurt themselves in order to do it. It seemed to me that hurting the Shia states was so important to them that the consequences for the rest of the world's oil related economy were relatively unimportant. I had thought that this was also Gwynne Dyer's view. I look forward to the opinions of others in this forum.
Aug 20, 2015 at 10:44am
Another factor, one that is in the Saudis' favor, is that Saudi oil is very cheap to produce: no need for fracking, or off-shore rigs, or drilling in inhospitable laces like the Arctic. Before the first "oil shock" of 1974 jacked the price to ~ $12/bbl, the cost of producing a barrel of oil, and delivering it to a tanker, in SA was about $0.25. The Saudis charged $3.00/bbl for it. In other words, even then the price was about 90% pure profit to the Saudis. And that wasn't enough for them!
And yet the loony left will tell us that it's the "Big Oil" companies that are making the obscene profits.
Aug 20, 2015 at 11:05am
We have been paying the manipulated price of OPEC oil for decades. The Saudi's oil has no relationship to the price they've been setting.
It could sell for $3.00 a barrel and they would make a profit.
But they need to buy off their disgruntled populace and, therefore, need something North of that price to do so. We should be encouraging, and buying, all the oil we can from our producers, even subsidize them, if need be. But this groveling Muslim we have in charge has made promises to the King to prop up his Kingdom so we'll have to wait till he's gone to do what's right, and wise.
George the doorman
Aug 20, 2015 at 11:31am
When supply exceeds demand prices fall - or so we were taught in Econ 101. And that is what we are seeing play out here, as producers around the world pump at or near capacity but demand is weak. As GD has noted, the amount of oil produced in the U.S. has more than doubled in a few short years driven by advances in fracking technology but also the very low cost of borrowing capital since 2008. At some point, higher cost and less efficient producers will exit and the market will find its equilibrium. But unlike in the past when there were few significant discoveries of new oil and barriers to entry were high, now any spike in price encourages increase in supply and prices will drop again. Barring a worldwide ban on fracking or serious disruption to Middle Eastern or Russian supply, the days of $100/barrel oil are over. There would be little point for the Saudis to voluntarily cut their production as other producers can now easily replace any shortfall.