Is the U.S. Also to Blame in the Oil Price War?

The Saudi-initiated oil price war has sparked a virulent reaction from some U.S. lawmakers, who accused Riyadh of waging “economic warfare” on the United States and threatened a host of potential reprisals, from economic sanctions to a halt to U.S. assistance for Saudi Arabia.

The problem is that the United States is probably as responsible as anyone for the plunge in oil prices. No country has added more oil to the global glut in recent years than the United States—and despite the recent plunge in crude prices, U.S. producers are still increasing output. That gives Moscow and Riyadh zero reason to swallow a financial hit on their own by lowering their own production levels, which in the meantime just increases the pain for all.

Nonetheless a half-dozen leading Republican senators wrote to U.S. Secretary of State Mike Pompeo this week, lamenting that America’s energy sector “is now under direct threat from a country that professes to be our ally.”

The escalation in the oil battle between the United States and Saudi Arabia comes as Pompeo’s failed entreaty to get Saudi Arabia to cut production and shore up plunging crude prices highlighted the difficulties of finding a supply-side fix to the damaging oil glut Riyadh helped create.

Since it decided to throw open the taps and drive oil prices sharply downward earlier this month, Saudi Arabia has resisted calls from Washington and elsewhere to rethink its strategy—much as Riyadh did during a similar period of oversupply and falling prices in the 1980s. Russia, the other big producer alongside the United States and Saudi Arabia, has recently indicated a willingness to resuscitate some sort of production agreement—provided everybody, including the United States, shares the pain.

This week, Pompeo urged Saudi Arabia to abandon its all-out production push and make sacrifices to help balance the global oil market—and throw a lifeline to U.S. producers. “Saudi Arabia has a real opportunity to rise to the occasion and reassure global energy and financial markets when the world faces serious economic uncertainty,” the State Department said in a readout of the phone call between Pompeo and Saudi Crown Prince Mohammed bin Salman.

But U.S. President Donald Trump has been ambivalent about wading into the oil war, cheering lower gasoline prices for consumers while noting the damage the price war has done to the Russian economy. While Pompeo and other U.S. diplomats and lawmakers have pressed Saudi Arabia to make cuts, Trump has not thrown his weight behind the effort.

“I’ll believe the White House is getting serious when they start engaging American companies and state regulators on the question of domestic cuts. That would get Saudi Arabia’s attention, I think,” said Matthew Reed, the vice president at Foreign Reports, an energy consultancy.

State regulators in Texas have toyed with government control of the amount of oil being produced—a throwback to a state-managed oil market from 50 years ago—as a way to restrain output and put a floor under prices, even as individual producers have continued to boost production. But there’s no consensus within the industry or among regulators about how to cut back U.S. oil output.

“Texas is going to cut one way or the other,” Reed said. “The question is do you want to do it involuntarily—or do you want to do it in a coordinated, strategic way that might also open the door for a diplomatic solution with other countries?”

Even if, as many forecasters expect, U.S. shale output falls by as much as 1 million barrels a day–the country currently pumps about 13 million barrels a day—that likely won’t happen until the second half of the year.

“Shale has to capitulate,” said David Goldwyn, the president of Goldwyn Global Strategies, an energy consultancy. “Until that happens, there is absolutely no incentive for any other producer to cut back, because it just extends the life of U.S. shale all over again.”

If there is so much pressure to cut production, it’s because there is an even bigger problem in the oil patch than massive oversupply: The global coronavirus pandemic has absolutely destroyed global demand for oil as entire economies in Europe and the United States come to a virtual halt. The International Energy Agency said Friday that oil demand could fall by 20 million barrels a day—a 20 percent decline—due to virus-related shutdowns, which would be by far the biggest oil-market shrinkage in history.

“The demand collapse is snowballing so fast it’s difficult to imagine anything being done by producers at this point to prevent an epic inventory build and more price weakness,” said Bob McNally, the president of Rapidan Energy Group, a consultancy. “It’s not a pretty picture.”

That combination of overproduction with dwindling demand has sent oil prices down about 66 percent since the beginning of the year, and with prices well below $30 a barrel, many oil producers, from Canadian tar sands to African offshore drillers to the U.S. shale patch, can’t make money. That means, according to oil industry consultants Wood Mackenzie, that an unprecedented wave of oil-well shutdowns are looming.

If benchmark global crude prices stabilize around $35 a barrel, about 4 million barrels a day of global production would be uneconomic and in danger of being shut down; if prices fall to $25 a barrel, some 10 million barrels could disappear from the market, Wood Mackenzie said—and some of it may never come back online, even if global oil demand recovers.

Some smaller producers will go out of business. Other big, mature oil fields that have to shut production during such a slump might not ever be able to come back online, whether because of the costs of restarting production or because of damaged oil reservoirs while they lay idle.

“Given the difficulties and costs associated with restarting mature production, a proportion of this supply may never return,” said Fraser McKay, the vice president of upstream at Wood Mackenzie, in a release.

That’s because many producers won’t survive. Brent crude fell about 6 percent on Friday to just under $25 a barrel, and while there are parts of the U.S. shale industry that can make money even with dirt-cheap oil, most can’t—they need prices closer to $45 a barrel to stay in the black. The recent plunge in prices has sent U.S. shale producers scurrying to slash investment plans, with many also trying to restructure their mountain of low-quality debt; the biggest U.S. producer just got downgraded from investment grade to junk status this week.

There are a few potential policies that Washington could reach for to limit the short-term pain. The Trump administration toyed with buying excess U.S. oil to put into the Strategic Petroleum Reserve, but it didn’t get funding from Congress. Oil companies could be eligible for some loan guarantees and financial assistance in the huge, $2 trillion rescue package the House is expected to pass today.

In the meantime, that pain for U.S. oil producers—a deliberate part of the Saudi and Russian strategy to claw back market share from a rival that has steadily increased output at their expense—is what is prompting so much ire against the Saudis in Congress, if not the White House.

“This relationship will be difficult to preserve if turmoil and hardship continue to be intentionally inflicted on the small- and medium-sized American companies that are at the heart of our nation’s energy abundance,” the lawmakers wrote. “By taking advantage of a confusing situation and desperate time, the Kingdom risks its bilateral relationship with the United States.”

Of course, Congress has in recent years taken a much tougher line on Saudi Arabia than the White House has, with bipartisan legislation over the Saudi role in the war in Yemen, the 9/11 terrorist attacks, and potentially unfair economic competition through its leadership in OPEC, the oil exporters’ cartel.

What’s jarring is that in years past, Congress sought to punish Saudi Arabia for making production decisions that raised the price of oil, which hurt the U.S. economy. In 2018, Congress yet again introduced legislation—known as “NOPEC”—that would allow U.S. antitrust action against Saudi Arabia and other big oil producers. Now, it’s attacking Saudi Arabia for doing the exact opposite—for not colluding with other big producers to manage the global flow of oil.

“It is sweetly ironic: The same people who are pushing the NOPEC legislation are also saying, ‘We are going to punish you unless you act like a cartel and start cutting production,’” said Goldwyn, a former U.S. State Department energy envoy.

If the recent collapse in oil prices—and U.S. inability to convince an allied country that is utterly beholden to it for military protection to change course—demonstrate anything, it’s that the notion of American “energy dominance” was always a myth. The United States can pump record amounts of oil, but only if other big oil producers allow it to.

“In the oil market, power lies with those that have spare production capacity, or set the marginal price of oil, and the United States has neither of these,” Goldwyn said. “We are not dominating, we are begging—for production cuts.”