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Why Saudi Arabia isn't sweating low oil prices

Saudi and Russian trade ministers have a pow-wow.
Saudi and Russian trade ministers have a pow-wow.
Pool/Getty Images

Thanks to stagnating Middle Eastern output and surging production from unconventional fields in Texas and North Dakota, in 2014 the United States has actually managed to surpass Saudi Arabia in the production of fuels (though not crude oil per se) and there's been a lot of speculation about the US becoming number one in crude oil next year.

This surging output from North America has been one of the factors driving down the price of oil lately. But that same price decline may lead Saudi Arabia to retake the lead. The reason is that Saudi Arabia's centrality in global oil markets doesn't just stem from the country's sizable reserves. Saudi oil is also really cheap to pump. So while expensive oil is better for the Saudi bottom line than cheap oil, even cheap oil is profitable. That is not the case for operations in North Dakota's Bakken shale formation. The operating costs in that play are high, and the cheaper oil gets the less it makes sense to engage in further exploration or pumping. The Bakken rig count is already slightly falling, and 2015 drilling plans are getting scaled back.

This is one reason the official Saudi line is to profess a lack of concern about falling prices.

Oil that's below $90 a barrel will throw the Saudi budget into deficit. But the Saudis have a big cash stockpile accumulated over the years. Oil that cheap will cause much more serious budgetary problems for the Saudis' regional rival, Iran. It's also bad for Russia, whose behavior in Syria has been at odds with Saudi policy. And Saudis hope that cheap oil will also crimp American production, effectively putting a floor under further price drops.

Of course this is not an uncontroversial strategy. Prince Alwaleed bin Talal, the ultra-rich Saudi investor potentate, recently released an open letter criticizing the Kingdom's official strategy of complacency. Even the biggest budget reserve will eventually go broke, after all, and further technical innovations could keep Bakken production profitable even at levels where it doesn't currently make sense. On the other hand, it's not clear what alternatives to "look on the bright side" are really available to the Saudis. Coordinated production cuts by all OPEC member states would work, but they're extremely difficult to enforce.

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