Saudi Arabia versus the Keystone Pipeline

Wow, I had barely recommended repealing the laws that restrict U.S. oil exports as part of an overall ramping up of competition in global oil markets when news hit that the Saudis were cutting the price of oil shipped to the U.S. The price of oil has been zigzagging downward since then—much to the benefit and delight of American motorists, who have seen gasoline prices fall, and to the angst of oil producers as lower prices squeeze profit margins.

Some may think that the Saudis are targeting American producers by cutting the price of crude oil shipped to the States even as they raised their price to Asian markets where the supply/demand balance is more in the Saudis’ favor. However, Stansberry & Associates resource analyst Matt Badiali points out, the sour crude that the Saudis are shipping here doesn’t compete directly with the light sweet crude coming out of American shale. The Saudis are competing with Canadian producers to whom, as Badiali shows, they have been losing market share. Since the Saudi cost of production is lower than the cost of producing oil from Canadian tar sands, it looks like the Saudis have the upper hand in a price war against the Canadians.

Of course, there are multiple factors here which make predicting the long term problematical: How much longer can the Saudis maintain their rate of production? How fast are the Canadians achieving economies of scale and advancing along the learning curve to reduce the cost of extracting oil from tar sands? Can the Saudis make up in increased sales volume the profits that they lose as the price of oil declines? What geopolitical events might throw a monkey wrench into the Saudis’ strategy?

Still, as of today and for at least the near future, the ongoing fall in oil prices has to be a major concern to Canadian tar sands producers. At what price point will lower oil prices force them to cut back on production? Given the possibility that producing oil from tar sands may become uneconomical, would building the Keystone XL pipeline through the American heartland still make sense for American companies and investors?

Indeed, the Saudi decision to drive down oil prices in North America means that the future prospects for the economic viability of the Keystone project need to be re-examined. President Obama has stubbornly refused to give the green light to Keystone. Wouldn’t it be ironic if, after squandering so much political capital on his obstructionist position, it turns out that market prices kill or continue to delay the project? Up until a few months ago, we needed Keystone—if not for actual production, at least as a sign that America was committed to the development of petroleum resources. The very commitment to increased energy production likely would have been factored into market prices, lowering them earlier has actually happened.

So, what now? Should the Keystone Pipeline be built? That’s not for me to say and, frankly, I don’t see the future clearly enough to know whether it will be economically viable in the coming years. Neither is it for President Obama to say or know. Only the market can tell us which decisions to produce are wise and which are mistaken.

Policy-wise, the president should simply get out of the way, call off his regulatory dogs, tell his green constituents to sit on it, and let entrepreneurs decide what risks they wish to incur. If they build it and lose money, well, it’s their money that’s being lost, not the taxpayers’ money as it has been for various Obama-financed alternative energy boondoggles. And if they do make money, it will be because they are supplying a commodity that Americans want and their addition to the total supply of oil will result in prices to consumers being lower than they otherwise would—in other words, a win-win situation for both consumers and those who took the risk to build and own the pipeline (with an added beneficiary being the government through its tax on corporate profits).

A final thought: The Saudis aren’t being “the bad guys,” even though those who hope to work on or otherwise profit from building the Keystone XL pipeline might wish the Saudis and their cheap oil would disappear. There are no “good guys” and “bad guys” in this strenuous struggle for market share. What we have in the oil markets is an example rough-and-tumble, unsentimental, take-no-prisoners nature inherent in competitive commodities markets. The sovereign consumer is in charge. Consumers decide which firms thrive and which die based on which ones best serve us. Consumers don’t care which particular producers supply our need for commodities—we just want to buy the commodity as cheaply as possible.

The oil market is working. We consumers—thus, society as a whole—are benefiting. In the competitive scramble to serve us, some producers will succeed while others fail. We should be grateful for them all, winners and losers, for each one of them, in their attempt to earn profits by supplying our needs has added to the competitive pressures that have pushed down oil prices. The cheaper oil gets, the more our prosperity will increase. Good luck to all the competitors, and thank you for working for our benefit.