Breaking News – OPEC dissolved as a meaningful organization at their Dec 4 summit.

Rather than adjusting OPEC’s production ceiling in an attempt to raise prices, or even generate a common policy to coordinate output, OPEC instead launched a production free-for-all. No longer will there be a quota – any quota. All members can now invest as much as they want, produce as much as they want, export as much as they want. Oil producers the world over are undoubtedly shivering in terrified anticipation. The Arab states of the Persian Gulf have by far the lowest production costs in the world, and if they do truly flood the market with low cost crudes, few – if any – have a hope of competing.

 

The Saudis’ goal can be summed up quite simply – force as many high-cost producers out of the oil markets as possible. This is accurate, but it is also incomplete. Yes, the Saudis would like to force its competitors to the financial breaking point, and yes, U.S. shale is an industry that the Saudis would like to wreck. But cracking apart the American shale sector is only one of many goals, and it is certainly not the primary one.

 

First and foremost, the Saudis are targeting Iran. With the Americans steadily stepping back from actively managing the Middle East, the Saudis are finding themselves forced to deal with their Iranian adversaries themselves. In this the Saudis are poorly positioned. While Saudi Arabia has plenty of top-notch military hardware, the Saudi people have no concept of what a military culture means. Iran has 30 years of experience building up insurgent movements and has proxies sprinkled throughout the Middle East. But the Saudis know full well that such proxies are expensive, and in a game of checkbook diplomacy the Saudis simply have more income and a bigger bank account.

 

Once sovereign wealth funds and less orthodox financial caches are factored in, the Saudis have – very conservatively — $1 trillion to throw at this problem, and that’s not even counting the personal assets of the royal family. The Saudis can sustain themselves in a low-price environment not for years, but for decades. Compare that to Iran’s hand-to-mouth budgeting. For the Saudis timing is critical; America’s rapprochement with the Iranians heralds increases in Iran’s oil output (albeit not likely in meaningful quantities until 2017). Best to drive prices down now and try to bankrupt Iran’s ability to wage proxy wars in Yemen, Lebanon, Syria and Iraq as well as the internal subsides that keep Iran’s population from revolting.

 

While Iran is clearly Saudi Arabia’s clear-and-present-danger, it is far from the only target.

 

Second on the list is Russia, whose oil output has risen to a new post-Cold War high. Russia is the world’s second-largest exporter, so a friendly Saudi-Russian relationship has never been in the cards. But the rivalry between Riyadh and Moscow is about more than just oil. The two have sparred indirectly for decades over the broad swath of weaker Muslim states that lie between them, and Russia’s ongoing rivalries with the United States consistently results in Russian actions that threaten Saudi interests. Russia’s intermittent sponsorship of Iran, and Russia’s involvement in the Syrian civil war opposite Saudi Arabia’s own proxies being cases in point. No wonder that the Saudis flooded the oil markets in the mid-1980s in a (successful) attempt to bankrupt the Soviet Union. No wonder the Saudis sponsored the mujahedeen in Afghanistan to gut the Soviet war machine. No wonder that the Saudis funded the Chechen rebellion in the 1990s. And no wonder the Saudi oil minister expressly called out the Russians when forcing upon OPEC the produce-as-much-as-you can policy.

 

oilsands

 

The third target of the new policy is a bit more obvious – those high price oil producers that have eroded Saudi market share over the decades, all of which are the prime beneficiaries of Saudi Arabia’s yesteryear policies of reducing oil output to bolster prices. With very few exceptions, none of these countries have ever actually reduced output themselves, instead relying upon the Saudis, Kuwaitis and Emiratis to bear the entire burden.

 

  • Canada: the world’s highest-cost producer is likely to be the biggest loser.
  • Norway: the Saudis particularly hate how reliable Norwegian output has been the past 20 years.
  • Russia: the multi-faceted nature of Saudi Arabia’s competition with Moscow earns Russia spot in this list as well.
  • Iran: with the strategic contest heating up, Iran also earns a double mention.
  • Libya: while its production costs are not all that high, the deepening civil war there threatens to remove Libyan production from the market completely. Lower oil prices could well be the factor that forcibly devolves Libya from chaos to anarchy – and destroys the entire energy complex.
  • Venezuela: while an OPEC “ally” who has always argued for lower production levels, Venezuela has not only never willingly reduced output, its output surges are what broke the 1970s Arab oil embargo – something that the Saudis have neither forgotten nor forgiven.
  • Nigeria: like Venezuela, the Nigerians have a nasty habit of putting Saudi money where their mouth is.

 

Collectively these countries are responsible for over 20 million barrels of daily oil output, and that oil income is responsible for the vast majority of their export earnings as well as the social stability that is required to produce the oil in the first place. As the Saudi thinking goes, break even one or two of them and a vast quantity of crude will fall off the market.

 

That just leaves us with American shale. When you add in the light condensates that shale output favors that are not technically crude, U.S. oil output is now above 12 million barrels per day. Largely courtesy of shale, American imports of crude have dropped by seven million barrels per day, five million of which used to come from OPEC members. Between shale’s success and continental integration, the NAFTA trio is now only two million barrels per day of outright energy independence. And by the end of 2017 the United States will surpass Qatar, Australia and Russia to become the world’s largest natural gas exporter.

 

basin-texas

 

Funny thing is, the Saudis were convinced until very recently that U.S. shale was just a PR campaign. They didn’t really admit shale was for real until 2013, and it wasn’t until 2014 that they realized shale would not simply reshape global oil markets, but contribute to the end of the American commitment to Saudi security. The Saudis would love to put a bullet in shale’s head.

 

But that time has already passed. Sure, back in 2012 the shale producers required oil prices at $90 or more to make a profit, but after a decade of technical advancement the industry is emerging from its infancy. New technologies like multi-lateral drilling and micro-seismic are vastly improving the amount of crude produced per well while vastly reducing the per-barrel production costs. More output per well means that surface infrastructure is now comprised of fewer, larger gathering pipes rather than an expensive crazy-quilt of tiny ones. New re-fracking and re-completion techniques are resetting older wells to their original output levels – or even higher. Taken together the full-cycle break-even price for the four major shale plays – Bakken, Permian, Eagleford and Marcellus – are already below $45 a barrel. By the time these new techs fully proliferate across the industry, the shale sector’s break-even is likely to be right around $30 – and that’s likely only a year away.

 

Which would put the destruction of shale firmly out of Saudi Arabia’s reach. But that’s ok.

 

The Saudis may miss on shale, but they have a very target-rich environment in front of them. There will be plenty of casualties.

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