As Sinatra might put it, this time we almost made some sense of it. We almost made that long hard climb to reduced dependence on Saudi Arabia for our oil supplies and diminished its ability to affect the fate of the American economy. Not that the technological feat of our frackers made us independent of imported oil. The Saudis will always have some power over the price of crude oil. The question is just how much power we want to cede to them.
Our relationship with Riyadh is complicated, to say the least. The rulers of Saudi Arabia fund the global spread of the theology that inspires radical Islamists and in which they find justification for their horrific tactics in pursuit of a caliphate. By pushing prices down, our frackers helped to make Saudi support for extremism more difficult, one of the reasons the kingdom decided that a real price war was needed to restore its pricing power. Hold oil below $50 per barrel for a time, and the U.S. industry will shrink, thus opening a path to permanently higher prices.
The Saudi desire to rid itself of meddlesome frackers is not exactly inconsistent with President Obama’s plans for our oil industry. He would prefer it go the way of coal, leaving it to the much-subsidized Elon Musk and other purveyors of electric cars to get us to the church on time, and to the grocery, and to visit grandma on holidays, so long as she lives within 200 miles. So the president is using the ever-pliant EPA and executive orders to rein in our frackers, make leasing of lands for development more difficult, and (for good measure) preventing us from increasing imports from a friendly Canada by vetoing a pipeline that would bring more of its ample oil output to our refiners. And he is doing nothing to prevent the Saudis from destroying our fracking industry with a tactic that can only be called predatory competition.
We have been enjoying a period of gasoline prices so low that motorists can drive more and still stash away about 5 percent of their incomes, compared with less than 2 percent in 2005. So low that the auto industry is having difficulty selling humdrum sedans (sales down 5 percent in the year ending in March) and tiny European-style vehicles. Consumers, knowing they can afford to fuel larger, more gas-guzzling but safer, more comfortable SUVs, are opting for those environmentalists' nightmares in greater numbers. By the 2017 model year the most affluent among them will be able to choose from Rolls Royce, Lamborghini, Bentley, and Jaguar SUVs, while the less-well-heeled will continue flocking to GM and Ford vehicles, the most profitable those firms produce. There are, of course, losers, but their anger is more than offset by the joy of motorists in a country in which our kings of the road are so politically potent that even a tiny increase in gasoline taxes is considered by politicians a one-way ticket to the private sector.
All of this thanks to the fact that our frackers developed and produced enough crude oil to enable us to join Saudi Arabia and Russia among the world's largest producers. Combined with nonrobust global demand as the world's economies struggle to achieve significant growth rates, the added supply of oil led to a price war and a plunge in prices from the $100 per barrel level that the Saudi-led OPEC cartel was extracting from consumers to half that, which was still high enough to make domestic oil production profitable and fracking an attractive investment. We had the answer to OPEC and its extortion right here in our hand, and then it "turned to sand," as the Jimmy Webb song continues.
No individual fracker in a fragmented industry can rival the financial clout of the Saudi kingdom, with something over $600 billion of cash on hand. Nor can any fracker produce oil at a cost as low as the Saudis can: To stub one's toe in the desert is to launch a gusher. So the Saudis decided to keep the taps wide open, flooding an already oversupplied market, driving the price down into the $30 per barrel range, from which it has recovered to around $40, primarily, says Rosneft's Igor Sechin, because the squeeze on American producers is working. All in all, non-OPEC oil production is down about 730,000 barrels per day.
The Saudis make no secret of their aim: to destroy the U.S. oil industry and, as an added bonus, Canada's. Saudi Arabia regards its huge oil reserves as a weapon and now as the time to use it, if it is to regain its earlier hold on our oil supplies. "Inefficient, uneconomic producers will have to get out, that is tough to say, but that is a fact. . . . We're going to let everybody compete," Saudi oil minister Ali al-Naimi told an audience of oil men in Houston in February. Sounds like a page from The Wealth of Nations. Except that it isn't.
The U.S. producers that proved such a thorn in the side of the OPEC cartel are being forced out of business. Some 60 North American oil and gas producers with over $20 billion in debt have filed for bankruptcy since the summer of 2014, and another 175 are at risk of not meeting requirements in their loan agreements. Some producers can break even or make some profit producing from existing wells, but new wells are an increasingly rare sight. Rigs drilling for oil are half the number active last year and, at only 440, are the fewest since 1999.
Three things make this more than mere competition of the sort championed by Adam Smith and our antitrust laws. The first is the stated intent of the leader of a worldwide cartel to drive U.S. companies out of business so that it can regain control of, and raise, prices. The second is the ability of the price-cutter to sustain prices below competitors' costs for an indefinite period: Not only do the Saudis have huge cash reserves that they are drawing down, they have the ability to borrow—a $10 billion loan is in negotiation with eager banks. Third, the Saudis do not fear that when their plan works and prices start to rise competitors will reenter the business and drive them down again.
Mr. Naimi, a graduate of Lehigh and Stanford Universities, knows how the oil and banking industries work. American banks have been badly burned, have had to increase reserves against dicey oil industry IOUs, and are now reviewing whether to continue making promised lines of credit available to the relatively small companies that are the backbone of the fracking business. To guide them towards a negative decision, Naimi announced that he can live easily with $20 oil, a real possibility after the collapse of the recent Doha meeting aimed at obtaining an agreement by major producers to cut output. Like bankers, singed investors do not want to "make investments based on something OPEC may or may not do," says Brian Ferguson, a Canadian oil sands producer. Even the big oil companies that have cut back exploration are unlikely to boost budgets when Naimi gets prices back to where he wants them: They know he can always drive them down if necessary. Besides, they worry that U.S. environmental policy will not allow them to produce what they do find, stranding those assets in the ground.
Michael Corleone might have been referring to what for a while seemed our success in reducing dependence on Saudi oil when he groused, "Just when I thought I was out, they pull me back in." So what's to be done to avoid that fate? Set a floor in the range of $50-$60 per barrel to enable efficient frackers to survive.
Yes, that means a tariff, sliding up as the Saudis and their cartel partners drive prices down. And it means higher prices at the pump now, but only to avoid still higher prices later. The macroeconomic impact can be reduced by lowering regressive payroll taxes, mitigating the impact on household budgets. Would that reduce our dependence on foreign oil? Yes. Would it reduce the Saudis' power to tip us into recession? Yes. Would there be unintended consequences? There always are. Is there a better way to spare any future president of the United States the need to bow before a Saudi king? I don't think so.