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Building shield

Imagine a world in which Queen Elizabeth II and her family holds absolute power over a wealthy, but oppressed, nation called Windsor Britannia. Such a scenario might seem absurd, but it is based on the very real example of Saudi Arabia.

What enables an absolute monarchy to not only survive, but flourish, fourteen years into the 21st century?

The answer has many facets, but the most important is oil. The Arabian peninsula is blessed (or cursed) with a geological resource that is both extremely valuable and easily monopolisable. It’s an example of geography determining history.

However, it can work the other way too – with history and culture helping to explain why some countries and not others are able to develop their resources. For instance, why is that America has by far the most important shale oil and gas industry of any nation, when shale deposits can be found around the world? The answer is that unlike most countries, America has a largish number of smallish innovative energy companies – providing a competitive, entrepreneurial environment conducive to the development of new techniques such as fracking and horizontal drilling.

As previously discussed on the Deep End, these two very different economic, technological and political models are now locked in a price war.

The standard narrative is that because shale oil extraction has much higher costs than the super-productive oilfields of the Middle East, the Saudis can afford to let the oil prices tumble while they watch the upstart frackers go bankrupt.

Writing for Quartz, Steve LeVine has a different take on the matter. He compares the position of Saudi Aramco – the state oil company – with that of Continental Resources, an Oklahoma-based shale oil producer:

“Western experts say that Saudi production costs average $10-$20 a barrel, give or take a few dollars either way. Of course, there are no hard public numbers when it comes to most Saudi oil data, only estimates from industry experts.

“But Saudi Aramco is only superficially comparable to Continental Resources. It is an arm of the Saudi government; the oil that it drills funds roughly 80% of the palace budget, which by extension covers Saudi education subsidies, low-priced energy, housing allowances and other benefits, not to mention lavish support for the lives and schemes of every royal family member.”

When you factor in the political costs, the oil price that the Saudis actually need to break even (i.e. balance the national budget) is $86 per barrel – which is way above what the frackers need to keep on fracking.

So, assuming that the Saudis really are deliberately allowing the oil price to fall, and haven’t just lost control of the oil market, how can they hope to win a price war?

“Because Saudi has socked away roughly $750 billion from the days when prices were high, including the average $106 a barrel that it earned for the three years prior to the current price plunge. The richest cartel members—Saudi Arabia, Qatar, Kuwait and the UAE—can test shale’s mettle not because their oil is cheap, but because they are willing to draw down on their tens and hundreds of billions of dollars in the bank.”

One hardly need draw the contrast with the economies of the West. The same goes for the shale industry, as the Economist explains:

“The share prices of firms that specialise in shale oil have been swooning. Many of them are up to their derricks in debt… Since shale-oil wells are short-lived (output can fall by 60-70% in the first year), any slowdown in investment will quickly translate into falling production.”

All, however, is not lost:

“…investments in shale oil come in conveniently small increments…  a shale-oil well can be drilled in as little as a week, at a cost of $1.5m. The shale firms know where the shale deposits are and it is pretty easy to hire new rigs; the only question is how many wells to drill. The whole business becomes a bit more like manufacturing drinks: whenever the world is thirsty, you crank up the bottling plant.”

This stands in contrast to conventional oilfields, which require huge, long-term investments to open-up – especially as the ones “that have not yet been tapped tend to be in inaccessible spots, deep below the ocean, high in the Arctic, or both.”

Putting together the pieces, there’s a lesson here in how to make our economies anti-fragile: don’t get mired in debt; make small, flexible investments; and don’t base your future security on a single resource.

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