Saudi Arabia and the war on shale oil that never ended

Last week when Saudi Arabia let it leak that the kingdom has no intention of leading OPEC toward another cut in production to accommodate the growing volumes of oil from American shale deposits, it was another sign that the Saudi war on shale actually never ended.

To properly understand this announcement, we need to return to last fall. Most people believed then that the cuts agreed to by OPEC under Saudi leadership marked the end of Saudi Arabia’s war on shale oil in America. At the time I cautioned against such a conclusion, and said I was doubtful that there would actually be any decline in world oil production because the Saudis didn’t really want a decline.

And, guess what? The OPEC cuts have yet to be fully implemented and have been offset by rising production elsewhere. And, the Saudis are now complaining that the Russians who, though not part of OPEC, agreed to cuts to support prices, are not keeping their end of the bargain. The Saudis are practicing a marvelous bit of misdirection to keep any blame away from themselves. With the Saudis, it’s always necessary to look at the entire game board in order to understand their moves.

So, why are the Saudis content to allow oil prices to remain this low and possibly drift lower? I believe it’s because their war on shale never ended; they mean to destroy the long-term financial viability of oil from shale deposits–and that job won’t be finished until investors say, “Never again!”

Apparently, investors in American shale deposits have very short memories or they have not had enough punishment. They continue pour money into the Permian Basin located in Texas and New Mexico. The Permian is likely to be the only U.S. shale oil deposit that will see growth in oil production this year as low prices continue to take their toll on other shale plays such as the Bakken in North Dakota.

But there are only so many profitable sites in the Permian, and with the continuing rush of capital into the area, the good ones will start to run short at some point. We’ll only know that’s happened when the second great wave of wealth destruction in the shale fields begins as I suspect it will in the not-to-distant future.

And don’t be surprised if the Saudis are content to let oil prices droop into the $20 range again just to get their point across.

As the next round of capital destruction begins, be prepared for stories about how dramatic efficiency gains in drilling operations are making it possible to bank profits in the Permian at an oil price of $40 per barrel. Then watch the same story repeat for $30 per barrel.

The last time we saw this movie there were dubious claims that oil in the higher-cost Bakken could be extracted profitably even with prices at $30 per barrel. As prices have stabilized around $50 per barrel, Bakken production has continued to decline. In part this has been because realized prices have been much lower due to lack of pipeline capacity. This has meant most Bakken oil must be shipped by rail tank car which is expensive.

Maybe this time investors will finally feel the pain from their shale investments so profoundly that even a subsequent substantial rise in the price of oil won’t lure many of them back. If so, the Saudis will finally achieve their goal, and the war on shale will end.

Resource Insights by (Kurt Cobb)