A Cold War Brews Between Saudi Arabia and Texas

 

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In addition to the war the U.S. and its coalition partners are waging against the Islamic State, there’s another conflict brewing in the Middle East—the intensifying oil battle between Saudi Arabia and Texas.

The fracking boom has pushed Saudi Arabia, the world’s cheapest major producer of hydrocarbons, to a very difficult choice. Either lose market share to upstart Texans, whose shale production is on the rise, or carpet-bomb the markets with cheap oil, hitting the pocketbooks of Wall Street investors who need high oil prices to get their money back.

Over the past few months, the Saudis have committed shock and awe on the U.S. stock market, wiping hundreds of billions of dollars in equity value from the market capitalization of U.S.-traded securities.

Why would they do that? Because of fracking.

The most important technological revolution on the planet in the past 20 years has been the widespread deployment of hydraulic fracturing for oil and gas production. Fracking has opened up huge amounts of hydrocarbons for economically efficient extraction in North America—much of it in Texas, which has been a technological innovator.

Fracking helps the U.S. economy and American drivers. Gasoline is at or below $3 a gallon for the first time in years. And because energy is the most important ingredient in economic growth, after people and capital, fracking has been great for the U.S. economy.
But the low oil prices are horrible for major producer economies such as Saudi Arabia, Russia, and Venezuela. Only Saudi Arabia is in position to punch back because it has the oil and cash to play hardball. And, it has played hardball before.

It costs the Saudis $20 per barrel or less to extract oil from their deserts. And since the world price has been oscillating around $100 per barrel for the past decade, the Saudis have been able to rake in hundreds of billions of dollars. They pull oil out cheaply and sell it for a handsome profit. Their entire society is built around this price gap.

For Saudi Arabia, technological innovation that increases volume and lowers price in the market is a huge problem. Fracking tanks the Saudi economic model. It is an existential threat.

Some nations respond to existential threats by declaring war, but don’t expect the Saudis, our longtime allies, to try to occupy the Eagle Ford Shale. They are doing something smarter.

Their weapon is to undermine the cash from Wall Street that is enabling domestic oil and gas production. The key here is that this shale boom is different—it was funded by Wall Street. Usually, oil companies fund their own drilling, but this boom was funded by outside money.

Russia, Venezuela and others are clamoring for higher prices. Saudi Arabia could cut back on production to increase prices and profit margins. But the Saudis seem content to have lower prices that cause competitors (namely U.S. onshore producers) to go bankrupt. Doing so guts the financial returns of Wall Street investors who might consider putting more money into American shale oil/gas production. That means there will be less money available to pay for drilling.

This is an expensive and shrewd maneuver. And Saudi Arabia has massive reserves—of both cash and oil—so it can wage this tactic decisively on Wall Street, the new battleground. It’s a battle for market share and price stability to push Texas back from encroaching on Saudi Arabia’s core business.

During the past 12 weeks the London spot price for Brent crude has fallen from $112 to below $84 per barrel as global oil production stays high despite softening demand. Saudi Arabia has signaled that it does not intend to ratchet back anytime soon.
What do we do now? We need to first recognize that we’re in the middle of a market war with severe economic and geopolitical stakes on the line. Second, we need to double down on what we do best: technology and innovation that will strengthen our hand. Third, we need to invest in R&D to keep driving production prices down and environmental protections up. Keep pushing efficiency measures to insulate our consumption from global volatility. Expand our pipeline and import/export capabilities so that our market is more nimble and can quickly respond to market dynamics.

When Saudi Arabia flooded the market in 1986, it throttled domestic oil production. But with a little more foresight and recognition of the risks, we can avoid that fate this time around.

This post first appeared at the Dallas Morning News.

 

 

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