An Oil Price ‘Cold War’ With Saudi Arabia?

It’s an oil-wrestling match – but it might only be as real as the WWE.

Last week, Saudi Arabia slashed its crude oil prices for the second month in a row – and unlike the last discount, this was exclusively for the U.S. market.

Saudi oil minister Ali Al-Naimi, the country’s top energy official, attends a meeting Sept. 11 in Kuwait.

Some experts declared it the start of a “cold war” with Saudi Arabia, as described by two University of Texas professors in an op-ed in the Dallas Morning News. Other analysts, however, contend that the Saudis are merely trying to defend against other exporters to the U.S.

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“There’s another conflict brewing in the Middle East — the intensifying oil battle between Saudi Arabia and Texas,” Isaac Barchas and Michael Webber, who teach at the University of Texas at Austin, wrote in the op-ed.

As Webber, deputy director of the university’s Energy Institute, describes to U.S. News, “Ford versus GM, Dell versus Apple: these are big companies duking it out for market share. Why would it be any different for oil. Is it a military war? No. But it’s a market share war.”

There are three main parts to his and Barchas’ argument:

1. Hydraulic fracturing, or fracking, has unleashed an energy boom here in the U.S., reducing net crude oil and petroleum product imports to their lowest levels since 1987.
2. With more oil now available on the market, combined with a sluggish global economy that’s reduced demand in Europe and China, benchmark Brent crude oil prices have fallen by roughly 27 percent since June – their lowest point in four years.
3. Saudi Arabia, the U.S’s.second-largest source of imported oil behind Canada, is trying to retain its market share by undercutting American producers. The goal: drive down prices far enough to scare away Wall Street investors or simply make fracking unprofitable, forcing U.S. companies to take their drill rigs offline to reduce supply and clearing the way for more Saudi oil imports.

As Chip Register, managing director of consulting firm Sapient Global Markets asserted in a blog post on Forbes, “The Saudis have put a bull’s-eye on the U.S. shale industry.”

Other experts, however, expressed strong skepticism with this view.

“It’s not a personalized attack,” Steven Kopits, managing director of the consulting firm Princeton Energy Advisors, says of the Saudi discount. “Saudi Arabia is looking out for its own interests, not trying to undermine other people’s interests.”

Men with Cabot Oil and Gas work on a natural gas valve at a fracking site in January 2012 in South Montrose, Pa.

Jan Kalicki, public policy scholar and energy lead at The Wilson Center, a nonpartisan think tank, agrees.

“Any real impact on shale in the U.S. is going to require more than a price adjustment of this kind,” he says.

U.S. shale fields can start and stop production relatively quickly. Technological advances, meanwhile, have sharply lowered the break-even point – no longer does fracking rank as one of the most expensive forms of oil production. It can still turn a profit at current prices of $80 a barrel, but depending on the type of well, fracking operations might even be able make money at prices as low as $55 a barrel.

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Hence, “trying to apply predatory pricing in the oil business will only work in the very short run, if at all,” says Paul Sullivan, economics professor at National Defense University.

So why did Saudi Arabia give the U.S. an exclusive discount on its oil? Because the country had two options, experts say: cut production or cut prices. Thirty years ago, the former yielded disastrous consequences.

Saudi Arabia’s estimated net exports of crude oil, in thousands of barrels per day.

From 1980 to 1986, facing a glut of oil on the market, OPEC – led by Saudi Arabia – slashed oil production to cut supply and drive up prices. The strategy was an abject failure: OPEC oil was simply replaced by oil from non-OPEC countries, and demand for OPEC oil plummeted. Saudi Arabia’s oil exports fell from 9.6 million barrels a day in 1980 to 2.8 million just five years later.

“It was a very painful lesson: You can’t set a price, the market sets a price. What you can do is set a volume,” Kopits says.

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Today, Saudi Arabia produces about 9.6 million barrels of oil a day. Slashing that production, Kopits says, isn’t an option – for now, anyway.

“If they start cutting production now to save the price, the last time they did this, they were forced out of the market for a generation, and they’re not going to do that again,” Kopits describes. “If they cut production, all they’re doing in Saudi Arabia is making room for U.S. shale.”

By cutting the price, however, Saudi Arabia boxes out not the domestic U.S. producers, but instead the other exporters it competes with: Canada, Mexico and Venezuela.

U.S. net imports of crude oil and petroleum products, in thousands of barrels per day.

“The Saudis are more likely going after non-US competitors to keep its market share,” Sullivan says. “It is a competition to capture a portion of the declining US oil import market.”

David Ottaway, a senior scholar at the Wilson Center, concurs.

“They are reacting to immediate market forces and trying to maintain their share of the U.S. market as it becomes less dependent on foreign oil,” he says. “If their current price cuts cause collateral damage to U.S. shale oil producers so much the better, but I do not think it is the primary reason for their action.”

And if the U.S. oil sector is to avoid that kind of damage – regardless whether it’s targeted or collateral – it must continue to drive down the cost of production, namely through investment and innovation, the Energy Institute’s Webber says.

“Cheap oil can cause a bust in the U.S.,” he warns. “We’re not the cheapest place to produce. But if we…drive down cost, that outcome might not happen.”