The Saudi ‘blink’ on oil production that wasn’t one at all

Last month, Saudi Arabia announced its intent to freeze oil production. Believing that someone had finally blinked in the global price war, oil markets rejoiced and the price of crude oil crept up for the first time in months. What traders ignored, however, were the caveats that populated Saudi Arabia’s statement, including that its proposal was conditioned on other exporting countries freezing their production as well. Needless to say, that’s a big condition. Yet little attention was paid to it.

{mosads}Shortly thereafter, the Saudi oil minister flew to Houston and announced that his country had no plans to reduce production and that the marketplace would muscle higher-cost oil producers into either cutting costs or liquidating. Huh? Wall Street and the oil industry were clearly baffled. Markets responded once again. The price of oil fell immediately. It is just now starting to inch up as the U.S. oil rig count declines. From the Saudis’ perspective, all of their statements were strategically sound; it was the rest of the world that was confused.

So, what really happened?

First, in declaring that it was freezing production, Saudi Arabia was not acknowledging its desire for a higher price, but declaring victory: It had suppressed prices and was intent on maintaining its production at record levels. The Saudis had determined that they had driven prices down enough to start reducing production among its higher-cost competitors. Their proof? Falling U.S. rig counts, growing financial liquidity issues among oil companies, and media reports detailing the exposure of banks to “bad” loans made to the oil sector and, ultimately, to the stock price of many unconventional oil producers.

Second, high oil prices did not advance Saudi Arabia’s foreign policy and security goals. A quick glance at the region’s political landscape underscores why it needs a low-cost oil policy at this time. For starters,

there is the Islamic State in Iraq and Syria (ISIS), which is opposed to the Sunni regime in Saudi Arabia and is active in selling oil to finance its activities in the Middle East. Of concern as well is the notion that Iran would reap a windfall as sanctions are lifted, putting Iran in a position to rejoin the global oil marketplace. Let me just add that it is not a coincidence that the Saudi production drive coincided with the signing of the P5+1 (the five permanent members of the U.N. Security Council, plus Germany) treaty with Iran.

This brings me to my next point about why the Saudis want oil prices to remain low. Beyond squeezing Iran on price, they want to squeeze Iran on access to Western capital and know-how. With virtually every oil company scaling back their commitment to capital expenditures, the Saudis are effectively denying the Iranians the investment and partnerships they need to rebuild their oil and gas infrastructure. A collapse in oil prices not only denies Iran a short-term influx of dollars it could use to fund groups active in terrorism, but delays Western investment in the critical infrastructure necessary to maintain Iran’s regional objectives.

As for the United States, policymakers are caught in a political hard place that even fracking can’t crack. On the left, there is tremendous pressure to “leave it in the ground” — a slogan embraced by presidential candidate Sen. Bernie Sanders (Vt.), who has pledged to ban fracking, and evidenced in the regulatory fervor of the Obama administration. In the middle and on the right, the posture is one of preservation, not only of our newfound energy security, but the jobs that have been created during the weak economic recovery. They understand the broader picture: Shutting down a domestic industry would weaken our nation, weaken our economy, and create even more dependence on oil from America’s enemies and from those who have fewer environmental controls on their oil production.

What’s needed now is for policymakers to create certainty in regulatory regimes governing oil and gas production — not construct barriers to production. The Senate energy bill championed by Sens. Lisa Murkowski (R-Alaska) and Maria Cantwell (D-Wash.) attempts to restore both balance and an economic path forward for continuing production.

Maddox has held several senior positions at the Department of Energy and is a consultant to the Livingston Group.