We are in a war with Saudi Arabia—and losing. The Saudis aim to regain substantial control of our oil supply by driving from the industry many of our shale-oil-producing frackers who have reduced the power conveyed to the kingdom’s rulers by the underground ocean of oil on which their palaces sit. And we seem prepared to let them do just that, by failing to do what is necessary to prevent a reversal of the major strides we have made to get out from under the boot of an avaricious oil cartel. Recall: That cartel is composed largely of countries that use their funds to sponsor, directly or indirectly, terror attacks on our country, and is led by Saudi Arabia, which uses its oil revenue to fund hate-teaching madrassas. As things now stand, if prices remain low we will find ourselves once again waiting for the Saudis to decide how much we should pay for oil, and watch the increased revenue from a price recovery flow into the Saudis’ overstuffed coffers, rather than being used to lower taxes here at home on work and risk-taking, providing relief for the middle class about which both parties profess such concern.
The application of our world-class technology to the drilling and production of crude oil produced what has come to be called the fracking revolution. U.S. production of crude oil increased 80 percent between 2008 and the end of last year, or by 4 million barrels per day. That increase is more than the total output of any OPEC country with the exception of Saudi Arabia. Until our drillers began extracting oil profitably from places previously thought to be beyond the reach of the drill bit, the Saudis controlled enough of the world’s oil production and reserves to have the power to set ceilings and floors within which the price of oil could fluctuate. They didn’t always use this power perfectly, but by and large sufficiently to assure crude oil prices—generally around $100 per barrel in recent years—that included significant monopoly profits. Perhaps even more important, the cartel led by Saudi Arabia had its hands on the spigots that could be turned off if some aspect of American foreign policy proved sufficiently distasteful to these Middle East autocracies and their fellow travelers. Of course, U.S. policy-makers have long known that, and factor that risk into their policy decisions; witness President Obama’s decision to cut short his trip to an important ally in order to pay homage to the departed King Abdullah, after failing to find an opening in his schedule to pay his respects to the fallen satirists and Jews of Paris.
Fracking so increased our domestic oil supply that OPEC’s pricing power could survive only if the Saudis made proportionate reductions in their own output. This, the kingdom decided not to do, for two reasons. First, its fellow cartelists, far more dependent on current oil revenues than the cash-rich Saudis, refused to cut their own output to bolster the impact of any Saudi cutback. Second, the Saudis decided to take the long view and liberate themselves from the ongoing threat of new supplies coming from the United States and elsewhere, by keeping prices low enough, long enough to eliminate higher-cost, less well-heeled competitors. In a drawn-out price war, the warrior with the lowest production cost and huge currency reserves—the Saudis’ stash is estimated at $740 billion—will surely be around long after higher-cost producers have been driven from business, especially those, like many frackers, dependent on bank credit and on repeated infusions of debt and equity capital.
Longtime Saudi oil minister Ali al-Naimi, who has retained his post under King Abdullah’s successor, insists in his public statements that the production cutbacks needed to prevent a further fall in prices, and to bring them back to levels more acceptable to the kingdom’s rulers, should come at the expense of the world’s higher-cost producers. That is a signal to his cartel colleagues to hang in there until the Americans sheath their drill bits. A pricing assault such as the Saudis have launched, followed by the clear intention and ability to recoup losses after competitors have been eliminated, is regarded by many economists and lawyers as predatory pricing, illegal in this country.
The near- and longer-term course of oil prices is difficult to predict; witness how many forecasters failed to foresee the more-than 60 percent drop in crude prices in a mere seven months. Most experts are guessing that prices will remain relatively low for the balance of this year and probably into the next, notwithstanding recent upticks. OPEC is expecting an oversupply of about two million barrels per day, more than 2 percent of world output, in part because it will keep its valves open, and in part because some cash-hungry shale producers can still cover operating costs.
Slower growth in China and virtual stagnation in the eurozone will dampen demand. And, at least so far, there are few signs that the use of energy is rising significantly in response to lower prices: Even though the fleets of SUVs flying off dealer lots will be hitting the roads, their impact is likely to be offset as the industry gears up to meet the draconian new fleet-wide Corporate Average Fuel Efficiency (CAFE) standard of 54.5 miles per gallon by 2025.
With demand unlikely to grow enough to bail out higher-cost producers, the lower prices that are likely to prevail will do what lower prices always do: squeeze higher-cost producers. America’s frackers are not the only producers the Saudis have in their sights as they battle to regain control of crude prices. Major oil companies operating in the North Sea, afflicted by high taxes and the high costs of maintaining their old fields, are also finding it impossible to maintain the level of activity that $100 oil supported. Experts have told the Wall Street Journal that some 1.4 billion barrels currently being considered for investment might just remain where they are—under the North Sea—unless prices rise substantially.
But the Saudis’ main target is the U.S. fracking industry. Schlumberger and Halliburton, suppliers to the oil industry, report that spending by their North American customers is dropping by 25 percent or more. Martin Craighead, CEO of Baker Hughes, which late last year accepted a $27.9 billion takeover from Halliburton, says the 7 percent drop in oil rigs working in America has taken the total to the lowest level in three years. In North Dakota, the second-largest oil-producing state behind only Texas, some 47 rigs have been idled, a drop of 25 percent. Time is running out on U.S. producers. The Saudis, of course, are not entirely unaffected: They have idled one rig.
When the Saudis went to war against shale, they were guessing that prices of around $70 per barrel would cause a slowdown in production. They undoubtedly are surprised that some producers say they can keep existing wells running at prices as low as $30 per barrel. But absent further technological breakthroughs there will be little investment in new wells at current prices. Indeed, even if prices do recover to close to $100, investors, seeing that the Saudis mean business when they say they and their colleagues will eliminate threats to their control of oil supplies, will find safer places for their money. Once the victim of successful predation, twice shy about taking on the predator.
This means that the Saudis are winning what turns out to be a longer war than they had hoped. This, even though they have to add the cost of the exorbitant welfare state that bribes dissidents into acquiescence, to their low cost of production, which means that in the long run they probably need $90 oil if the regime is to survive. But that’s the long run. Saudi reserves are sufficient to get them through the short run, and in the long run most frackers will be dead.
The policy implications of their demise for our economy, and for national security, are profound. Lower crude prices have transferred wealth from bad guys like Russia and Iran, and from unstable countries such as Nigeria, which depends on oil for 95 percent of its exports and 75 percent of government revenues, to American and European consumers. These prices have deprived Iran of funds it badly needs to keep its economy functioning and its nuclear program rolling, increased pressure on the sanctions-hit Russian economy, and if sustained will put pressure on Saudi Arabia to think again about the generosity of its funding of hate-spewing Wahhabi clerics (it was, remember, mostly Saudi men who took down the World Trade Center).
Meanwhile, that wealth transfer has been a boon to consumers, who are using their newfound bonanza to shore up their balance sheets and to indulge in a bit of discretionary spending. Motorists can expect to pay an average of $2.33 per gallon to fill their tanks this year, about $1 per gallon and $750 per household less than in 2014. Throw in an additional $750 for those who heat their homes with oil, and the savings move from nontrivial to significant. True, thousands of oil workers and shareholders, those who serve beer and sandwiches to roustabouts in North Dakota and upscale meals in Houston, and banks that lend to smaller producers are hurt by the fallout. But there is little doubt that in America the winners far outnumber the losers.
Unfortunately, the wealth transfer from bad guys to us deserving consumers will be reversed if the Saudis win this war. Which they will, unless we take as long a view as the Saudis. In the long run it is in the interest of the American economy and national security to keep the power of the Saudis and their colleagues over us at a minimum. That power cannot be reduced to zero, except in the unlikely event that oil follows what seems to be the place environmentalists intend for coal—into the dustbin of history, with the wind always blowing and the sun always shining. But that power can be reduced if we develop policies that help to keep the American oil industry growing and profitable, even at short-run cost to consumers. “Defense,” said Adam Smith when considering restrictions on free trade, “is of much more importance than opulence,” and a bit of insurance against oil supply disruptions and price spikes is of more importance than a few cents on the price of gasoline. Especially when lower prices today, if they devastate our oil producers, mean higher prices in the long run.
This brings me, with considerable reluctance, to suggest a protective tariff; protective not of the special interest of the oil industry but of the national interest, with the oil industry merely a collateral beneficiary of a policy that might be of significant benefit to us all. The question is not whether a tariff on imported oil would create some undesirable consequences: It will. The question is whether it would create fewer undesirable consequences than a return to the days of unchecked Saudi power, especially if the regime comes under increasing pressure to give kindlier consideration to the needs of Iran than it has been inclined to do in the past.
A tariff could be set so as to vary inversely with the price of oil. It could set a floor of perhaps $65 per barrel, low enough to encourage continued improvement in the efficiency of the American industry, high enough to allow its survival in the face of Saudi cuts below that level. The industry rule of thumb is that a $10 rise in the price paid for crude oil in the United States would result in something like a 24-cent increase in gasoline prices. Is that a great deal of what Smith called “opulence” to give up, especially since the lower price we now enjoy would only be available in the short run if the Saudis regain pricing power? And it may well be that such a tariff could be coupled with a termination of subsidies to producers of oil, gas, nuclear power, wind, solar, and other energy sources—all of which would benefit from the tariff—leaving U.S. taxpayers about even. In any event, the tariff should hit higher-income owners of energy-consuming big cars and houses harder than families living in smaller houses and driving smaller cars, a form of redistribution, being based on energy prices, that even the sturdiest conservatives might find tolerable.
The Saudis would hate it. And we are told that we need their help with security operations and other matters. But encircled as they are by Iran and its proxies, they need us even more than we need them, making their security services unlikely to pout, sulk, and refuse to share information merely because we are protecting our oil industry from their oil policies.
Better ways of preserving our current respite from enslavement to a group of oil producers that do not wish us, or our wells, well are welcome.
__This article originally appeared in the February 16, 2015, Vol. 20, No. 22 issue of the Weekly Standard.__