To implement its oil market share stabilization policy, Saudi Arabia is launching a three-prong price war against the United States, Russia and Iran. With objectives including oil and political strategy, Saudi Arabia is increasing oil production and cutting oil price. The other three countries, which are involved separately in the Saudi oil-price war, are firing back using different weapons.
The Russians are getting back at the Saudis by sending more sophisticated weapons to Syria and Iraq, the dessert kingdom’s major foes in the Middle East. The Iranians are supporting the regime in Syria and the uprisings in Bahrain and Yemen. They are also undercutting the Saudi oil price in East Asia. Now, after a series of price cuts in that region and counter-cuts from Iran, Saudi Arabia is surprisingly raising its oil prices there.
The Saudi war on the U.S. is oil-related since both countries are political allies. The Kingdom has recently been targeting the shale boom in the U.S., which is now 43 percent of total oil production and about 60 percent of total natural gas production. The Saudis are currently “dumping” oil on the U.S. by selling it below the global price.
They want to lower the oil price in this country to slow the growth of shale production. Although they cannot be effective in cutting the current U.S. production they can hurt future production growth.
The U.S. is implicitly threatening that it would use a diversified battery of economic weapons to counter the Saudi attack and keep oil prices from dropping significantly to protect the shale industry. One measure that the U.S. is contemplating is adding to its strategic petroleum reserve (SPR).
Oil is relatively cheap and it makes sense for the U.S. to store more oil and increase the oil reserves. This counter measure should keep oil prices from going down to a level that can hurt the future growth of the shale industry. The more the U.S. government will buy, the greater the support for oil prices. This price support amounts to place a price floor under the U.S. oil price.
Another weapon the U.S. can level against the Saudi oil involves imposing tariff on this oil. A tariff is a trade barrier that can raise the oil price globally since the oil market is global and not regional as is the case for the natural gas market. Under the tariff, all oil prices in the U.S. should go up, which can benefit the shale industry. However, this measure may go against the World Trade Organization’s rules, which outlaw imposing tariffs on non-agricultural goods.
Another option is for the U.S. to impose a quota on the exports of Saudi oil to the United States. This measure is equivalent to the tariff but is more opposed by WTO as quotes are more harmful than tariffs. However, this weapon is not very effective, as the Saudi oil exports to the U.S. has diminished with the increases in domestic shale production.
The U.S. can also lift the oil exports ban. Lifting the ban means exporting the trapped oil in the U.S. overseas but this would lead to lower global oil prices. However, this measure should help the shale industry export its oil surplus to foreign countries but it is likely to reduce global oil prices.
Even so, BP has started doing it despite the ban using the ultra-light quality of shale oil as an excuse to go around the export ban, which is only applied to crude oil. This weapon is a double edge sword.
Another good thing is that the cost of shale is not constant and is downward trending. The efficiency of fracking has improved 300 percent since 2011. This translates into lower production for extracting shale oil, which implies that the breakeven price that can break the back of shale extraction would drop over time. This will impose heavy burden on the Saudi budget.
A more political maneuver could be that the United States may stir more political dissent within Saudi Arabia and the Middle East. This is the quickest and most effective weapon to counter the Saudi offensive of lowering oil prices. This measure should increase the political risk premium component of the oil price and prop up the breakeven price for the shale industry.
Having said all that, Saudi Arabia could have a friend in the United States that may help in the war against oil shale production. This ally is the American public. There is a growing movement against shale fracking in the U.S.
Vermont is the first state to ban shale fracking. In the midterm election which took place Nov. 4, Denton, Texas which is considered the birthplace of fracking, voted against it. The people of Denton have already experienced what fracking can do to personal lives and they want to live fracking free.
Los Angeles and Beverly-Hills, California have imposed a moratorium on fracking. This may slow the growth of fracking, which is what the Saudis want. This topic will require a separate discussion.
Saudi Arabia will find this oil war very costly and distressing. They should find a better way to deal with the fracking issue. They should also reconsider their current oil-war strategy and seek cooperation within and outside the Organization of Petroleum Exporting Countries. The other oil exporters including Russia and Iran should also cooperate with Saudi Arabia if they want to avoid this fruitless oil price war.
Shawkat Hammoudeh is an economics professor at Drexel University. He can be contacted at [email protected].