How Saudi Arabia Is Winning Its War Against the US Oil Industry

Like most industries where investment gets paid off by assumptions about future profits, the oil industry borrows money. A lot. And that strategy has worked for the past century or so. Even during the Arab oil embargo of the 1970s.

But the industry that thought it had put its competitors away by doubling down via fracking suddenly found that the Saudis, understanding that their way of life (and maybe lives) were threatened if they didnt maintain primacy called their bluff. If there is one element in diplomacy that causes otherwise rational actors to panic, it is an opponent behaving irrationally, at least according to the extant rules of the game.

So the Saudis gambled that low prices would hurt the Americans - who are more dependent on outside financing - more than it would hurt the Saudis who provide their own financing. And that is looking like a pretty smart bet. JL

Ben Casselman reports in 538 blog:

Oil companies have survived low prices this long because banks and investors were willing to lend them billions of dollars on the assumption that the price plunge would be short-lived. But as experts become increasingly convinced that prices will stay low for years, Wall Street is turning off the money spigot.
A bit over a year ago, Saudi Arabia declared war on the U.S. oil industry. This week brought new signs that the Saudis might at last be winning.
Some quick background: Saudi Arabia has long played the role of the “swing producer” in the oil market, meaning that they tried to stabilize prices by pumping more oil when prices went up and pumping less when prices went down. But that was before the fracking revolution led to a surge in U.S. oil production, eating into Saudi Arabia’s share of the oil market and (along with other factors) driving down prices. In late 2014, the Saudis decided they weren’t going to cut back their production to accommodate new U.S. crude. Instead, they turned on the taps full-blast, betting that by flooding the market they could chase U.S. oil companies out of business. (This is a simplified version of this history. For a fuller version, see Steve LeVine’s excellent piece on Quartz.)
At first, it looked like the strategy was failing. The flood of crude successfully drove down prices, and U.S. producers cut back on drilling in response. But the wells they did drill were so successful that total production barely budged. And when prices rebounded even a bit, as they did briefly last spring, U.S. producers went right back to drilling, pushing prices back down.

Recently, though, there have been signs that the Saudis’ strategy might be working after all. On Monday, Chesapeake Energy, once the highest flier of the U.S. oil boom, had to deny publicly that it was preparing to file for bankruptcy; some 60 oil companies have already done so, and the research firm IHS estimates that as many as 150 companies could follow suit. On Wednesday, The Wall Street Journal reported that private-equity giant KKR & Co. was backing away from risky bets on oil companies. Industry leaders are starting to sound desperate: The New York Times quoted the head of a Texas oil group as telling his members that “today our goal is to survive.”
Oil companies have survived low prices this long because banks and investors were willing to lend them billions of dollars on the assumption that the price plunge would be short-lived. But as experts become increasingly convinced that prices will stay low for years, Wall Street is turning off the money spigot. (It doesn’t help that the global economic slowdown is making banks more cautious, while the Fed’s decision to raise interest rates is making borrowing more expensive.)
The money crunch is hitting just as U.S. production is starting to decline. On Tuesday, the Energy Information Administration estimated that production is down 600,000 barrels per day since April; the agency expects production to fall at least that much again by the end of the year. Without a cash infusion, those declines will only accelerate.
If production is falling, does that mean oil prices are going to go back up? Maybe. A popular argument in the oil patch is that the pullback in investment is sowing the seeds for the next surge in prices; oil companies won’t be able to boost production quickly enough when it’s needed, leading to higher prices. But even if that argument is right, it could take years for such a rebalancing to occur. And besides, as I’ve argued before, the conventional wisdom on oil is (almost) always wrong.