By now, it should be obvious that the Saudis and their Gulf allies are playing the long game when it comes to the current oil situation, and that means keeping the taps flowing in the midst of a global glut no matter how low prices go.
The strategy is designed to drive out higher-cost producers of heavy oil and shale, whose rapid development is squeezing Middle East crude out of the huge U.S. market and threatens to eat into its share of other lucrative growth markets. There are other compelling, though unstated, reasons for the Saudi stance, including a desire to make life miserable for feared arch-foe Iran and give the West a helping hand in reining in Russia's geopolitical ambitions. The Saudis have been eager to stick it to the Kremlin for years over its cozy dealings with Tehran and its decision to renege on a deal to match OPEC production cuts in 2009.
The damage from the oil plunge is already hitting producers of more expensive crude in various outposts from Alberta to the North Sea to the fracking fields of Texas and North Dakota. But when it comes to sidelining the hydraulic-fracturing outfits for any length of time, it may be a tougher proposition than the Saudis think.
Still, anyone who doubts the Saudi resolve to stick it out even if oil tanks to $20 (U.S.) a barrel hasn't been listening to what the architects of this policy have been saying – or else mistakenly believes the Saudi royals will cave because they face a yawning budget deficit and potentially dangerous social unrest if they make deep cuts in social spending.
"It is not in the interest of OPEC producers to cut their production, whatever the price is. Whether it goes down to $20, $40, $50, $60; it is irrelevant," Saudi Energy Minister Ali al-Naimi declared last month. He has subsequently stated this is not merely a policy for 2015 but "forever."
Forever might be a bit of an overstatement. But among them, the Saudis and smaller Gulf states have more than enough cash stashed in reserves, as well as sovereign wealth funds – at least $3-trillion in various funds they can tap – to wage this price war for years.
"They can hold out at $20 [a barrel] for a decade if they have to," says Peter Zeihan, a geopolitical adviser and author of The Accidental Superpower. "They're not under short-term financial pressure like other [producing] countries. But I'm not sure shale is either."
True, many shale projects become economically dicey when prices fall much below $80 a barrel. But costs vary from deposit to deposit, and some can still break even at levels closer to $50. And even though drilling has dropped off sharply in the major Bakken field in North Dakota and other fracking plays, it is remarkably inexpensive to restart once prices rebound.
"You're looking at full-cycle costs in places like Bakken being well below $50 already," Mr. Zeihan says. "I don't mean to suggest that protracted low oil prices aren't going to put a crimp in shale. But I don't think it's going to hurt it nearly as much as a lot of people are fearing. The real damage is going to be to those projects that are very high-dollar and take a decade to bring on line."
And that's where shale producers can gain even more traction over heavy oil and offshore rivals, not to mention the Saudis.
"If you have a two-year delay in starting the next oil project, you're going to see output declines three to five years from now," Mr. Zeihan notes. "It's a hiccup that shale can fill, because a really expensive, really complex shale well takes five weeks to drill and costs $20-million. While you might not get the return per barrel, that's such a lower investment risk that as soon as you have any sort of bubble-up in prices, the shale drillers will go in and take the market share."
So ultimately, the Saudi gambit will only strengthen shale's hand.