U.S. and Canadian Oil Drillers Frack the OPEC Cartel

Gasoline is cheaper at the pump this week, my dental technician commented on it just today. And I am relieved that I can fill the Subaru Forester for under 50 bucks. Estimates are that, should current prices hold, the average American consumer will save $1,100 a year. Keynesians pray he will spend it, to ‘stimulate’ the economy; I hope he will save it to ‘stimulate’ the economy by increasing America’s capital available for investment—the key determinant of both employment and pay levels.

Since June, the price of a barrel of oil has dropped some 40 percent from more than $100 a barrel to around $65. But relief at the pump and money to spend or save are the bread and circuses of the story; behind that cheerful façade, of course, are upheavals of world politics on a historic scale.

To put aside pretense: No one knows for sure why the price of the world’s indispensable natural resource has plunged some 40 percent in six months. The only factor we know for sure, and can quantify, is that during that time the U.S. dollar, in which international oil is priced, has increased in value 10 percent, accounting for roughly a $10 drop in the $100-plus price of oil.  The rest of the precipitous price decline has to do with demand (depressed economies consume less power), but also supply. Most commentators speculate that supply is the real story.

Since World War I, but particularly during and in the aftermath of World War II, the Middle East became a dominant, and, then, obsessive, focus of the developed world—meaning Western Europe, the then Soviet Union, North America, Japan, and a few other nations. There certainly were other sources of oil: Texas, Oklahoma, Alaska, and the Gulf of Mexico in America; the North Sea oil fields off Scotland; Venezuela; and, when the Soviet Empire imploded, Russian oil fields. But no oil reserves were remotely comparable to those in the Middle East, especially Saudi Arabia, the United Arab Emirates, Kuwait, Iraq, and Iran. All other oil fields were being depleted; the Middle East oil reserves seemed inexhaustible.

And so the Arab nations, plus Iran, increasingly held the key to prosperity or calamity for developed economies.  In the 1970s, in retaliation for support of Israel by the United States, Middle Eastern nations shut off oil entirely, helping to send America and Europe into depression and runaway inflation.

Although relations between the United States and the great oil producers, especially Saudi Arabia, have become regularized and cooperative, there have been—to say the least—irritations. For example, all 19 of the terrorists who brought about the 9/11 catastrophe were Saudis, as was their chief and mastermind, Osama bin Laden. Responding to 9/11, the United States invaded Afghanistan, and later Iraq. But nary a word was said against Saudi Arabia and the hyper-virulent brand of Islam its governing sheiks promote.

And that’s how things seemed to remain, on the surface—indeed, with competition for Middle East oil becoming fiercer with gluttonous demand from the new economic prodigy, China. But things had started to change—slowly at first, and then, momentously.

The change was driven in large part by the sky-high price of oil maintained by the Organization of Petroleum Exporting Countries (OPEC), especially Saudi Arabia—despite the fact that it costs Saudi Arabia an estimated $2 to produce a barrel of oil it was selling for $100 or more.

Oil trapped in layers of sand and shale—huge pools of oil, matching Saudi Arabian reserves—were theoretically accessible in North America and Canada by using highly sophisticated new drilling technology such as horizontal drilling and the much-criticized ‘fracking’. Oil sands and shale in Calgary, Canada; the Permian Basin in Texas and New Mexico; and the Bakken fields in North Dakota were awaiting oil prices that would make drilling profitable even by very expensive extraction methods.

Obligingly, world oil cartels such as OPEC, including many covert funders of radical Islam; adversaries of America such as Russia and Venezuela; and violent locales in Nigeria kept the price of oil as high as possible without quite cratering U.S. and European economies (their customers). But higher prices for oil meant that extracting those U.S. and Canadian oil deposits became realistic and profitable. By about a decade ago, American entrepreneurship was in full swing, with big investments from venture capital firms and support from investment in the stocks of the new companies.

And so we reach today’s moment of truth.

As recently as June, the price of a barrel of oil hovered above $100. Iran, Saudi Arabia, Russia, and Venezuela all celebrated a vast transfer of wealth from the United States, Europe, Japan, and China to their own treasuries.

And then, the oil price started to fall–and has kept falling for five months in a row. Offered as an explanation is the depressed state of economies in the United States, Europe, and Japan—and reduced economic growth in China—and so less demand. Except that most of those economies had been far weaker after the 2008 financial crash and the United States, at least, has been recovering and growing again. And yet, only now is oil price plunging.

And so the other explanation. Not because of actions of the Obama administration, which has continued to limit drilling for oil off-shore and in Arctic waters, opposed a pipeline to bring Canadian oil to world markets, and resisted fracking, but as a result of extensive new high-tech drilling on non-federal lands, either private or state controlled. And because of the steady defiance by the new oil pioneers of opposition by environmentalists and regulators at every turn.

The vast oil reserves around Calgary, the Bakken, and the Permian Basin have come on line and, at least for now, are glutting the world with oil. After literally decades of talk about United States ‘energy independence’ from Islamic Arab states, Russia, and the Venezuelan socialist dictatorship, America is rapidly becoming a leading world oil producer on par with Saudi Arabia.

And so we arrive at last week. Alarmed by the plunging price of oil—and of revenues that are virtually the only income of countries like Saudi Arabia, Russian, Venezuela, and Iran—OPEC met in Vienna to decide how to respond.

One choice: Reduce their own production, thus tightening supply, and hope that this would lift the international price of oil. Countries desperately dependent on oil prices for survival pleaded for this choice.  It was not to be. The leading oil-producing nations like Saudi Arabia, with (very temporarily) huge financial reserves, adopted a longer-range strategy of price war. They gambled that by keeping the price of oil low, they could cripple, perhaps destroy, the new North American oil producers.

As mentioned, the long-established (mostly by Western companies) oil fields of the Middle East, with their infrastructure in place, can produce profitable oil at a few dollars per barrel. But the new, sophisticated technology of the North American oil producers requires a much higher ‘break even’ price for oil. Roughly, overall estimates are that the North American producers can drill profitably at about $60-$70 a barrel. Oil today (December 5) closed at around $66 a barrel.

And so the lines of the battle are defined. If the oil price recovers from the current $66 a barrel, or at least falls no farther, domestic oil producers can drill and American energy independence just might become a reality. If so, we will be able, at last, to tell Saudi Arabia, Iraq, Iran, Russia, and Venezuela to ‘get a life’ apart from selling hyper-expensive oil to us. Iran will become far more dependent on integration into the world economy and even more vulnerable to economic sanctions. The great bankrolls behind the surge of Islamic radicalism will diminish. Russia may hesitate to finance armies in other countries, such as Ukraine. And China may start buying oil from America, reversing the flow of U.S.-Chinese trade and the balance of payments.

Today, no one can be sure what direction this price war will take. The new drilling technology is expected to get cheaper, over time, and more capital investment will mean more productivity. Nor can most OPEC oil producers survive long at a price of $60 a barrel: not because their costs are high but because they have built big welfare states on hyper-high oil revenues.

Nor is the United States—in theory—helpless to influence the outcome. For example, the Obama administration could ease environmental regulations and costs, enabling oil producers to lower their costs. The Obama administration could open arctic and off-shore waters to oil drilling, increasing the domestic supply at lower cost. It could give start-up oil companies special tax status.

Of course, it will do none of those things. The role of our government, it seems, is to appease environmentalists by regulating, controlling, and limiting production by the private companies.

Energy—and for historic reasons, oil—is the motor of the world. When there are seismic shifts in production and flow of energy, there are earthquakes in world politics. Earthquakes, for all our efforts, are unpredictable. But if the shift toward North American producers is real and enduring, then governments—and even nations—may rise or fall.

This essay first appeared in Financial Sense, an investment Web site. 

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About the Author: Walter Donway

Walter Donway has written and edited for Savvy Street since its inception in 2014. His essays and interpretative commentaries on breakthrough books have dealt with philosophy, politics, literature, science, history, psychology, and personalities. His new novel, "Retaking College Hill,” became Amazon’s #1 bestseller in political fiction. This year, the Atlas Society published his Pocket Guide to The Fountainhead and Romanticism Reborn--essays on the Romantic movement in literature and its 20th Century revival in Ayn Rand's novels. His collections of essays and short stories and his "Collected Poems" are available on Amazon. He lives in East Hampton with his wife, Robin.