The empire strikes back: Saudi Arabia takes on U.S. shale


HOOK IT UP: An unidentified oilfield worker ties pipes to be raised on an oil rig as the sun sets in the Persian Gulf desert oil field of Sakhir, Bahrain.

By Rob Nikolewski │

Drivers are enjoying a drastic drop in gasoline prices but behind the scenes, the oil-rich nation of Saudi Arabia appears to be playing a game of economic chicken with U.S. shale producers whose technological advances have completely reshaped the world’s energy landscape.

“They want to prove to the world that they’re still in control,” energy analyst Dan Steffens, president of the Energy Prospectus Group in Houston, told

The price of a barrel of oil has plunged nearly 40 percent since late June, and since Thanksgiving the drop in gasoline prices has accelerated so fast that some areas of the country may soon see the price dip below $2 a gallon.

THE SAUDI SQUEEZE PLAY: OPEC leader Saudi Arabia appears to be trying to put pressure on U.S. shale oil producers in an attempt to protect its share of the global market.

Using horizontal drilling and hydraulic fracturing, U.S. oil producers in places like the Bakken formation in North Dakota, Pennsylvania’s Marcellus shale and the Permian Basin in West Texas and eastern New Mexico have spearheaded a more than 30 percent boost in U.S. oil production in recent years.

The increased supply has driven down the cost of a barrel of oil and put the squeeze on Saudi Arabia and the other 11 members of the Organization of Petroleum Exporting Companies, known as OPEC.

In a meeting Nov. 27 in Vienna, despite pleas from some OPEC members to cut production to bring global prices back up, the Saudis announced they would keep on pumping, presumably to protect their market share. The strategy? Keep prices on a downward trend and apply pressure on the U.S. upstarts.

“They wanted to show the other OPEC members they’re still the kingpin,” Steffens said in telephone interview.

“We call it the OPEC, or the Saudi Arabia shakeout,” Thomas Watters, managing director for Standard & Poors Ratings Services told Bloomberg News. “They’re clearly targeting the North American shale producers.”

Saudi Arabia is still the largest producer of crude oil in the world, but the U.S. has been giving the Saudis a run for their money. In the past four years, American producers have completed an estimated 10,000 new wells — more than 10 times what the Saudis have completed — and the U.S. output of almost 9 million barrels a day is just 1 million barrels short of what Saudi Arabia produces.

OPEC nations — and Saudi Arabia in particular — have realized that “this boom in the United States is not a bubble that’s going away,” energy analyst and author Daniel Yergin told CNBC just prior to the Thanksgiving OPEC meeting.

It seems the Saudis’ strategy is to keep pumping and starve shale producers in the U.S., many of whom will be severely tested as the global price keeps dropping. On Thursday, benchmark U.S. oil prices fell below $60 a barrel for the first time since July 2009.

“You’ll see people trimming their budgets back,” Steffens said.

It’s already happened, with drill permits dropping in four of the major shale “plays” across the country:

Source: Michael Fitzsimmons, Seeking Alpha website

Smaller producers who carry relatively high amounts of debt are particularly vulnerable.

But the Saudi power play comes with some risk.

First, the economies of OPEC members Venezuela, Nigeria and Iran are dependent on high oil prices. Their economies are a mess, and they’re angry with the Saudis’ decision to keep prices low.

And second, while Saudi Arabia’s oil resources are deep, there’s some question about whether the kingdom can hold out as long as some experts expect.

“I think they were thinking, this (U.S. oil production) wasn’t really a threat before but now we do think it’s a threat,” Steffens said. “And if we don’t nip it in the bud now, it’s going to be more painful later.”

Over the weekend, OPEC secretary general Abdullah al-Badri denied the organization was out to get U.S. shale producers. “Some people say this decision was directed at the United States and shale oil,” Badri said through an interpreter while speaking to a Kuwaiti news agency. “All of this is incorrect. Some also say it was directed at Iran and Russia. This also is incorrect.”

Can the U.S. shale producers hold out?

“I don’t think we’ll see a decline in production. What we’ll see is a flattening,” Steffens said. “(Production) went up a million and a half barrels a day this year. Well, it will probably cut that in half next year.”

But in the long run, Joseph Dancy, investment partner at Dallas-based LSGI Advisors Inc., insists the shale industry will survive.

“We’re in the first inning of a nine-inning game,” Dancy said. “Even if there is a slowdown, the oil is still in the ground and the technology to extract it is getting better and better.”

The Saudi-U.S. showdown figures to be a test of nerves at the highest economic level, but for now drivers can keep enjoying low gas prices.

As pointed out in the The Economist magazine, the typical American motorist spends about $3,000 a year at the pump. The recent price drop translates into about an $800 savings — the equivalent of a 2-percent pay raise.