THE BLOG
01/05/2015 12:39 pm ET Updated Mar 07, 2015

Sheiks vs. Shale: the Future of O.P.E.C.

MARWAN NAAMANI via Getty Images

OMAN - America enjoys scolding the rest of the world. It certainly enjoys ragging on the Organization of Petroleum Exporting Countries (O.P.E.C.), which the West largely credits for holding the magic wand of setting world oil prices. As the price of crude benchmarks has plunged by nearly 50 percent since June, many commentators are now calling into question O.P.E.C.'s ability to control pricing and bring stability to the markets. Accordingly, U.S. shale producers and their Wall Street investors are hanging on the every word of O.P.E.C.'s de-facto leader -- Saudi oil minister Ali al-Naimi -- as if he is either an oracle to be heralded or an untrustworthy demon to be castigated.

After O.P.E.C. convened in Vienna on the 27th of November and chose to maintain its production ceiling of 30mn barrels a day, the West continues to blame the organization (and Saudi Arabia, as its top producer) for further plunges in the oil price. Meanwhile, America is patting itself on the back for partially contributing to the glut in world oil supply from its own domestic production of light tight oil (L.T.O.) via hydraulic fracturing, or "fracking."

While the low oil price calls into question the commercial viability of some of these high-cost shale operations, setbacks are viewed as temporary. Unlike the behemoth oil company "Majors," U.S. shale producers can quickly reduce capital expenditures for drilling, which will slow production growth. In a high price environment, they are able to resume drilling, armed with brighter and better technology. In theory, these sparkling new tools are meant to further reduce the cost of drilling, making L.T.O. production commercially viable and sustainable.

LOW OIL PRICES ARE VANQUISHING RUSSIA

While the U.S. is afforded the luxury of getting high on its own supply of shale, eminent voices from the Beltway claim America is vanquishing its enemies such as Russia, as their export-dependent economies are crippled by the low oil price. Former Cold War warriors smile with delight as they remind themselves that Gorbachev's decision to dissolve the Soviet Union was in part due to a plunge in oil price and a crashing rouble -- a historical moment that mirrors the present. One such warrior -- Ed Luttwak -- has provided the U.S. with an Axis of Evil 2.0, in which the "room for maneuver" of the "antagonists" of Russia, Iran and Venezuela has been "seriously reduced."

With a perceived abundance of its own shale resources, America is able to look on as the plummet in the price of oil is "stoking financial crises" in Russia and Venezuela. Some even venture to claim that -- in addition to the secret weapon of Pope Francis, the crash in oil prices might have led to Havana's eventual decision to restore diplomatic relations with Washington.

While many in the U.S. forecast the downfall of the regimes of pesky petro-crats, O.P.E.C. is deemed to be a "toothless tiger" that is losing its clout.
Even Saudi observers are proclaiming "O.P.E.C.'s irrelevance." Be that as it may, some of the major producers that make the organization are far from irrelevant: namely, Saudi Arabia, Iraq, Kuwait, Qatar and the U.A.E.

'NEVER AGAIN' / BUSINESS AS USUAL

Western energy analysts claim that Saudi Arabia -- as O.P.E.C.'s unofficial leader -- presented a "fundamental change" in policy by deciding to maintain output at 30mn barrels a day. In reality, it is not a radical departure at all. Rather, it is entirely consistent with the policy the Saudis set for themselves after the watershed year of 1986.

At the time, the price of oil plunged to $10 a barrel, and Saudi's output was reduced to 2.3 mn barrels a day (from approximately 10 mn barrels a day before the crash began, in 1981). This was a shocking and psychologically devastating moment that threatened the institutional survivability of the Kingdom: hitting the floor of production deprived the government of its primary source of revenue. According to the Nov. 28, 2013 issue of the Middle East Economic Survey, the Saudis vowed to "never again" allow its production to reach the floor. Consequently, some of the best minds in the global energy industry were brought in to collaborate with Saudi-born, U.K. and U.S.-educated engineers and economists in order to create an optimum economic number for the Kingdom's oil production -- an ideal level that would help them balance their fiscal needs and vast energy reserves for generations. The magic number was set between 7 and 10 mn barrels a day.

This was a careful, calculated policy which -- accounting for some adjustments in cost differential and pricing -- has remained the same ever since. Maintaining O.P.E.C.'s production ceiling of 30 mn barrels a day -- and offering discounts to Asian purchasers to withhold market share -- is a clear continuation of Riyadh's policy. It is business as usual, rather than a sudden shift. (It is perhaps worthwhile to note that current O.P.E.C. chairman Ali al-Naimi presided over Aramco as Chairman during the crash of Saudi production of 1986).

And -- contrary to the imaginings of Washington and Wall Street -- Saudi's decision is purely commercial. It is the product of sophisticated engineers and economists. The business decisions taken in Dhahran are about dollars, riyals and common sense. Because of the prudence and careful consideration with which it was set -- and because the end goal is the lifeblood of the Kingdom -- the magic number of 7-10 mn barrels a day is kept separate from the political machinations of Riyadh.

'SHEIKHS VS. SHALE'

Like the garish shale energy C.E.O. Harold Hamm, many in the U.S. would like to claim that Middle Easterners "can't live with these prices." But in reality, they can. Between them, Saudi Arabia, Kuwait, Qatar and the U.A.E. have a "war chest" of some $2.5 trillion. A few years of low energy prices may rattle the piggy bank, but it won't break it. These countries have some of the lowest production rates in the world (Kuwait's breakeven cost is around $52 a barrel). Even gas-rich Qatar is sitting pretty: it enjoys the highest savings rate in the world, at over 58 percent of G.D.P.

The best thing that O.P.E.C.'s Middle Eastern members and their neighbors can do is to seize the moment and curtail lavish public spending in the form of civil service salaries and fuel subsidies. Iran and Egypt have already taken stringent measures in this direction -- and the I.M.F. recently lauded Egypt on its efforts. In fact, Moody's changed its outlook for Egypt from "positive" to "stable," reflecting the agency's "expectations of an improving economic empowerment." And even with an ever-increasing influx of Syrian refugees, Lebanon's banking system has proved to be incredibly "resilient": and the S&P gives it a stable outlook. Of course, because we in the West view the Middle East as a hotbed of civil war, dissolving states and Islamic extremism, we can't fathom that others may be achieving economic livelihood in the midst of such chaos.

But rather than clicking our heels and wishing for regime change from our "antagonists," the single greatest thing we can do is assist the oil and gas-exporting nations on diversifying their economies. This is a way to work for the livelihood of the people, who will be there beyond any leaders -- be they crony or "democratic." In the long run, creating jobs and economic empowerment is far more likely to contribute to stability than lining up undesirable heads of state like a set of dominoes to be toppled, a la Axis of Evil. Naming and shaming oil-rich enemies is an expensive policy, and Washington should opt for a different path -- especially when, despite a short burst of shale, the U.S. continues to rely on O.P.E.C. supply to meet its own resource needs.

Sourcing for statistics: Middle East Economic Survey (M.E.E.S.), 28 November 2014