The reality of the matter has turned out to be significantly more straightforward: U.S. and Canadian producers were adding millions of barrels a day in new production to world markets at a time when global demand was incapable of absorbing so much extra crude oil. An unexpected surge in Iraqi production added additional crude to the growing glut. Meanwhile, economic malaise in China and Europe kept global oil consumption from climbing at the heady pace of earlier years and so the market became oversaturated with crude. It was, in other words, a classic case of too much supply, too little demand, and falling prices. "We are still seeing a lot of supply," said BP's Dudley last June. "There is demand growth, there's just a lot more supply."
A War of Attrition
Threatened by this new reality, the Saudis and their allies faced a painful choice. Accounting for about 40% of world oil output, the OPEC producers exercise substantial but not unlimited power over the global marketplace. They could have chosen to rein in their own production and so force prices up. There was, however, little likelihood of non-OPEC producers like Brazil, Canada, Russia, and the United States following suit, so any price increases would have benefitted the energy industries of those countries most, while undoubtedly taking market share from OPEC. However counterintuitive it might have seemed, the Saudis, unwilling to face such a loss, decided to pump more oil. Their hope was that a steep decline in prices would drive some of their rivals, especially American oil frackers with their far higher production expenses, out of business. "It is not in the interest of OPEC producers to cut their production, whatever the price is," the Saudi oil minister Ali al-Naimi explained. "If I reduce [my price], what happens to my market share? The price will go up and the Russians, the Brazilians, U.S. shale oil producers will take my share."
In adopting this strategy, the Saudis knew they were taking big risks. About 85% of the country's export income and a staggeringly large share of government revenues come from petroleum sales. Any sustained drop in prices would threaten the royal family's ability to maintain public stability through the generous payments, subsidies, and job programs it offers to so many of its citizens. However, when oil prices were high, the Saudis socked away hundreds of billions of dollars in various investment accounts around the world and are now drawing on those massive cash reserves to keep public discontent to a minimum (even while belt-tightening begins). "If prices continue to be low, we will be able to withstand it for a long, long time," Khalid al-Falih, the chairman of Saudi Aramco, the kingdom's national oil company, insisted in January at the World Economic Forum in Davos, Switzerland.
The result of all this has been an "oil war of attrition" -- a struggle among the major oil producers for maximum exposure in an overcrowded energy bazaar. Eventually, the current low prices will drive some producers out of business and so global oversupply will assumedly dissipate, pushing prices back up. But how long that might take no one knows. If Saudi Arabia can indeed hold out for the duration without stirring significant domestic unrest, it will, of course, be in a strong position to profit when the price rebound finally occurs.
It is not yet certain, however, that the Saudis will succeed in their drive to crush shale producers in the United States or other competitors elsewhere before they drain their overseas investment accounts and the foundations of their world begin to crumble. In recent weeks, in fact, there have been signs that they are beginning to get nervous. These include moves to reduce government subsidies and talks initiated with Russia and Venezuela about freezing, if not reducing, output.
An Oil Glut Unleashes "World-Class Havoc"
In the meantime, there can be no question that the war of attrition is beginning to take its toll. In addition to hard-hit Arctic and North Sea producers, companies exploiting Alberta's Athabasca tar sands are exhibiting all the signs of an oncoming crisis. While most tar sands outfits continue to operate (often at a loss), they are now postponing or cancelling future projects, while the space between the future and the present shrinks ominously.
