A recent Wall Street Journal article opens a window into a new and unsettling world. More chaos in the oil markets and more instability in the Middle East.
Saudi Arabia sought to raise crude oil prices by driving US Shale producers and other low cost producers out of business. That is, by setting the oil market on fire with a flood of oil, they would set a price so low, US producers would have to shut in and stop drilling. They reasoned it would do two things.
But the strategy blew up in their faces for several reasons.
Now they are caught in a trap of their own making. The only option is to reduce their own output and suffer the revenue hit. Will that be enough to make a difference? Probably not. Both of its Gulf neighbors, Iran and Iraq have spare capacity and are only too willing to grab market share. US shale producers are also hungry to sell more oil and will add production as long as the marginal cost exceeds the current price. That is now somewhere between $40 and $60/barrel and falling as producers get more efficient and focus on their most economic assets.
A real possibility is for more, not less, oil to come to market. If all the other producers have more productive capacity than the Saudi’s withdraw from the market, trust that it will be used. All indications are that this is the case. This implies that the price ceiling will come down, adding pressure to all producers to reduce costs. OPEC members really have but one option, reduce social costs. The consequence of that is likely to be more, not less instability in already shaky nations.