Saudis put the squeeze on the shale frackers.

Photographer: Reza/National Geographic/Getty Images

OPEC Tries Stamping Out Frackers

Justin Fox is a Bloomberg View columnist. He was the editorial director of Harvard Business Review and wrote for Time, Fortune and American Banker. He is the author of “The Myth of the Rational Market.”
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Whenever anybody struck oil in the U.S. in the late 19th century, Standard Oil’s pipeline guys showed up within a few days and offered to hook the new well up to the network.

Actually, "ordered" might be a better word. Pipeline boss Daniel O’Day was a master in the less-delicate arts of persuasion. And if anybody else tried to put in pipes to carry the oil, build refineries to transform it into kerosene, or set up retail networks to sell it, Standard Oil found ways to drive them out of business and/or buy them out.

Oil Prices

“We had to do it in self-defense,” Standard Oil chief John D. Rockefeller Sr. told an interviewer decades later. “The oil business was in confusion and daily growing worse. Someone had to make a stand.” (Why yes, I did get all of this from Ron Chernow’s brilliant Rockefeller biography, “Titan.” Thank you for asking!)

Competition in the oil business was, in Rockefeller’s view, a terrible thing -- wasteful, counterproductive, conducive to crazy booms and busts. And while oil discoveries far from Standard’s original Ohio base, plus the 1911 court ruling that broke the Standard Oil Trust into 34 separate companies, put an end to Rockefeller’s monopoly, it didn't end the striving of the industry’s leaders for order and control.

After the Standard Oil breakup, and the emergence of the Middle East as the center of world oil production, it was the Seven Sisters oil companies, three of them progeny of Standard Oil, that together controlled 85 percent of world oil reserves and on occasion colluded to keep markets orderly. Then oil-rich countries joined forces in the Organization of Petroleum Exporting Countries (OPEC) and began nationalizing their resources. After the Arab oil embargo of 1973, they imposed their own sort of order on the oil market.

This is what OPEC’s members are still trying to do, with Ali Al-Naimi, Saudi Arabia’s longtime minister of petroleum and mineral resources, doing his best to play the part of Rockefeller. As Bloomberg’s Grant Smith reports, Al-Naimi and his counterparts from Kuwait and the United Arab Emirates have made clear in recent weeks that they are out to thwart an unruly new band of competitors who have helped send oil prices plummeting over the past six months.

These competitors are the frackers, American wildcatters who have been pumping huge quantities of oil and natural gas from ground that until recently was seen as not worth the effort (another reading recommendation: “The Frackers,” by Gregory Zuckerman). That some of this shale-filled ground lies not far from the western Pennsylvania oilfields where Standard Oil got its start just makes the story that much better. As does the fact that, as a smart, soft-spoken man in a nice business suit who spent a lot of time in Pennsylvania (he’s a graduate of Lehigh University), Al-Naimi -- the former head of the national oil company, Saudi Aramco, itself a descendant of Standard Oil -- isn't entirely miscast in the Rockefeller role.

Al-Naimi doesn't, however, have all the tools at his disposal that Rockefeller did. He can’t send a bunch of Saudi Aramco toughs to Pennsylvania or Texas or North Dakota to threaten the wildcatters. He can’t really buy out the frackers, either. So what he and his closest Arab allies are doing instead is pumping more oil in an attempt to drive prices even lower -- so low that the American frackers start losing money and shutting their wells. This could work, Shawn Tully writes in Fortune, because fracking (hydraulic fracturing) is relatively expensive. Once you’ve drilled a conventional oil well, the cost of pumping doesn’t amount to much, so you keep pumping even when oil prices plummet. With fracking, the break-even oil price is much higher -- above $50 a barrel for almost every U.S. shale-oil project, according to Bloomberg New Energy Finance (the price on the New York Mercantile Exchange for West Texas Intermediate crude is, as I type this, $48.37 a barrel).

After OPEC succeeds in shutting down a lot of frackers (if it succeeds), the Saudis and friends would then presumably cut production and return global oil markets to a state of order and higher prices. Of course, if the prices go high enough, fracking will recommence. That would take some time, though. Once-burned investors would be more cautious. And the oil majors, among them Standard Oil descendants Exxon Mobil and Chevron, which have been mostly spectators to the fracking boom, would have the opportunity to buy in at fire-sale prices. I suspect that Al-Naimi would like that last part a lot: A market dominated by a few big players is just so much more civilized than a scrum of wildcatters.

It may even be that a more civilized, orderly oil market would be better for consumers of petroleum, too. When it comes to resource prices, predictability is good. Rockefeller’s OPEC successors have never really succeeded, though, in keeping prices steady enough to be predictable. Repeated discoveries outside of OPEC territory (the North Sea, the North Slope, and now the U.S. shale fields), competing priorities within the organization, and the inevitable ups and downs of the global economy have kept crude prices swinging from high to low and back since the early 1970s. Still, we can expect that Al-Naimi and his closest OPEC allies will keep striving for control. That’s just what oil magnates do.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Justin Fox at justinfox@bloomberg.net

To contact the editor on this story:
James Greiff at jgreiff@bloomberg.net