Saudi Play To Regain Control Of Oil Market May Backfire

The global price of oil is dropping, causing ripples in economies all over the world. For some, the lower oil prices are a good thing. For others, the lower oil prices mean falling revenues. Russia's oil income has dropped to the point where it no longer provides enough funds to run the government. Venezuela's already pathetic economy is getting even worse as its oil income decreases and its ability to even provide oil diminishes. For some countries, like Saudi Arabia, oil is its only material export and when oil prices fall the Saudis can't keep paying for its inhabitants benefits. Under those circumstances the Saudis tend to do something that at first seems counterintuitive: pump more oil and force the prices even lower.

What this accomplishes is that it makes it unprofitable for oil producers requiring use of more expensive means of pumping oil to dial back production or to stop producing oil at all because the cost of producing it is higher than what they can sell it for on the open market. This has the effect of crippling other oil producing nations' petroleum sales and reducing the number of competitors in the world oil market. This isn't the first time the Saudis have done this. It's worked for them in the past. But there may be two problems with such a strategy this time that could just as easily cripple the Saudis, too: Even though the supply of oil has increased many fold, demand has not, at least in the US; and the cost of fracking is dropping at an increasing rate even as its ability to increase production goes up which in turn means the cost of producing oil from the shale formations will drop as well.

As more nations start to embrace fracking as a means of producing oil domestically, the downward pressure on oil prices will continue which would force the Saudis to try to produce even more oil. This would force oil prices into a downward spiral the Saudis might not be able to survive particularly, as their oil fields are older and their ability to produce more oil may not exist. When its competitors may have more oil reserves than they do, such a strategy can be a loser. With just the US now having oil reserves many times that of Saudi Arabia and that total going up every day, the Saudis are going to find their window of opportunity to take control of the oil market is closing. As other nations like Russia and China resort to fracking, the Saudis' grip on the oil market could end. That could leave them as minor players and their ability to buy off the more radical citizens could end.

This is one of those “Good News, Bad News” scenarios that could have effects far beyond the Middle East. It could be that over the next decade or so we will be living in “interesting times”.